For business leaders considering an initial public offering, one of the key questions is: How large should the IPO be? Many associate IPO’s with hundreds of millions of dollars or billion-dollar valuations. Certainly, “bigger is better” generally applies to the public securities market, however, the size of deals getting done vary widely as do the reasons.
Here are a few of the factors most often considered when setting valuation:
What’s happening at comparable companies? Much depends on the business itself, the industry it serves, as well as the general global economic environment. Your offering and your business’s specific financials will be evaluated against comparable peers in the marketplace. If peers in your industry are consistently achieving high valuations, your company is likely to benefit from being able to raise more with less dilution. If multiples are routinely lower, then investment banks will look closely at how attractive the deal will be to the market, and dilution in light of amount to be raised has to be considered.
What is happening with your business? In evaluating the size of an offering, potential investors will ask how has your business made money, where do you want to take it and how much capital is reasonably required for the enterprise to achieve its goals?
For instance, a REIT primarily makes money from renting or repositioning property. Investors might ask, how large must a portfolio be in your asset class to purchase additional assets, thus creating value? Depending on their asset class, REITs also should have significant property holdings out of the gate, starting around $100 million in assets. Also, how quickly can money be deployed? A long lead time from an IPO to the proceeds being fully deployed and looking to more capital for growth is unlikely to impress potential shareholders.
How many shares are in play? “Volume,” or the number of shares actually trading on any given day, and “float,” or the number of shares available to trade, are critical to share prices for companies going into the public markets. Companies sometimes want to offer as few shares as possible, for instance, to ensure ownership and control remains the same after going public. But a too-conservative approach can harm a company’s IPO prospects. Propose an offering that is too small, and a few poor trades can have a significant effect on share prices.
A larger issuance also makes it easier to gain the attention of industry media and analysts – who can create buzz around the stock and enhance its value. Enough stock should be trading to allow your lead book runner to build a syndicate around the stock. The syndicate will help sell the stock quickly, and more importantly, will form an ongoing trading community in the stock.
The smaller the issuance, the less likely that larger institutions or investors would be willing to participate. These types of investors do not like to be too large a position in any one issuer. Obviously, these types of investors can also provide the most capital.
Is the IPO worth it? The valuation process can also give the company another opportunity to evaluate whether an initial public offering is worth the burden. Once a company goes public it must grapple with a far greater regulatory burden, and significant legal, governance and accounting costs. The costs will be ongoing as well – and now that the company is public – must be reported. The offering should be large enough to justify these new costs.
Alternatively, how much capital will be needed in the future? The public markets are the most efficient source for capital. If you’ll be coming back to the public markets on occasion to fuel the growth plan, then perhaps you can justify the costs and scrutiny now.
- What will sell a smaller IPO to investors? Though larger IPOs are more likely to get noticed, smaller deals are getting done. The rule of thumb is the smaller the deals they are, the greater growth potential they must demonstrate. Generally, operating businesses want to be looking at a minimum issuance of $25 million. For REITs, the minimum is more like $50 million.
If the deal is too small, the offering may not qualify for one of the larger and more accepted national exchanges. The smaller the exchange, the less likely large sophisticated investors may participate.
Deploy your funding rapidly and grow rapidly, and you can turn a low IPO valuation into significant appreciation. Remember, though, the market is always watching.
At Kaplan Voekler Cunningham & Frank, we have long experience helping companies, investment banks and investors large and small navigate the IPO process. We also help companies with offerings like those under Regulation A, which allow them to reach the broader trading public and tap into market capital, but without the costs associated with a tradition public offering. Contact us to learn how we can help.