Some Thoughts on What Makes an IPO Successful

1. State of the economy in general; state of the industry sector
If the economy is growing, investors generally look more favourably into investing into shares. From the other side, if the industry sector is in favour with investors and the prospects for the sector seem more promising to prospective investors than some other sectors, the issuing company has more reasons for success. This can be broadly described as a rule of supply and demand in the market that are the functions of the number of investors and money on the market, the availability and prospects of alternative investments with the same level of risk, and even the mood of investors.

2. Quality of the company
The company should be mature enough for the IPO. It should be able to show a track record of growing profit generation through reliable sources of profit data and forecasts of future cash flows. They may even be considered as required prerequisites of a flotation, because without them the company is not likely to receive support even from a reputable sponsor. The only exceptions to this rule to date are the Internet companies whose current difficulties are in fact confirming this rule. Gillian Hastings, a corporate finance partner with Ernst & Young, says: “Gone are the days of floating on the promise of future profits. Today’s flotation candidates must have high growth prospects, coupled with strong revenues and profits” .

Another important factor is the track record of the directors of the company: whether they had business success in the past and a genuine commitment to the company.

The strength and clarity of the company’s strategy, and the ability for investors to form a clear idea about the company’s prospects are also very important issues. Tim Draper, the founder and MD of Draper Fisher Jurvetson, a leading venture capital firm in Redwood City, California, says: “A company going public must have a clear vision of its market and the steps it will take to dominate this market” . Douglas Pihl, a founder of NetStar Inc., a successful IPO, says: “You have to have a clear, concise story on why your company is going to be successful, why it’s unique, and you have to be able to tell this people in a way they can understand” .

Other prerequisites are:
• Cleaned up company accounts (in the absence of abnormal issues)
• Adequate accounting policies
• Adequate capital structure
• Sensible organisational structure
• Sufficient financial internal controls: “Well before an IPO managers must put in place the financial controls necessary for running a public company” – Tim Draper, Draper Fisher Jurvetson .

An important issue that does not have an immediate impact on the success of the IPO but can have an enormous impact afterwards is the necessity to disclose in the prospectus all the important information regarding the company. The prospectus must adequately and completely convey the risks associated with the investment. IPO as a corporate event involves probably the most serious potential liability for the company’s directors .

3. Decisions to be taken before the flotation
There are also a number of important decisions regarding the mechanics of the flotation that could significantly influence its success.

3.1. Choice of the sponsor of the issue
Choice of a sponsor (typically a merchant bank that manages the issue and advises on all its aspects) is critically important:
• Involvement of the sponsor in recent flotations and their positive results to some extent increase the company’s chances for success in IPO
• If the sponsor is a big firm with good reputation on the market, it typically has extensive contacts among institutional shareholders, is an effective marketer and has sufficient financial resources to back up the issue if necessary. From the other side, unlike the floating company, which is a newcomer to the stock market, the sponsor operates on the market all the time. Any prior unsuccessful flotation is a significant blow to the firm’s reputation, therefore when a company secures the support of a well-known sponsor, a successful flotation is more likely because it is assumed that the company has done the necessary preparations and is being fairly to investors
• The company managers need to spend very long hours with the sponsor representatives, and the ability to get on well is important

Needless to say, the careful choice of other partners for the flotation process, for example law and accounting firms, is also very important. These firms should be experienced with IPOs and public company presentations.

3.2. Communication of the reasons for going public
Considering the two main reasons for flotation - “cash in” (when the company seeks raising capital to finance growth) and “cash out” (when existing shareholders seek the opportunity to sell their shares) - different types of investors are attracted. So, it is important that the company has correctly revealed its reasons for flotation not to confuse potential investors.

3.3. Choice of the stock exchange on which to float
The choice of the target market will, to a large extent, influence the success of a stock. For example, considering the US market, it is known that the shares of technological companies are more successful on NASDAQ, where investors perceive their risks lower than technological shares traded on NYSE.

Because the cost of flotation on different exchanges varies relatively insignificantly, companies have the temptation to float on major stock exchanges, for example, London or New York. However, such a choice may often not be in the best interests of the company. For instance, it often makes sense for a medium-size company not to float on a major exchange where it would be “a little fish in a big pond” and neither analysts nor investors really pay much attention to them.

3.4. Chosen method of going public
There are two most common methods of going public: an offer for sale – offer to the whole market, to both institutional and private investors - and a placing, where shares are offered to a limited number of selected institutional investors. This choice defines the whole strategy of the flotation and should be carefully chosen according to the needs of the company.

4. Marketing and presentation of the company
The following general marketing issues on the preparatory stage of the flotation also have a significant impact on the success of an IPO :
• General publicity is created to increase the prospective investors’ awareness of the company and its attractiveness as an investment. Because companies to be floated are not generally known by the market beforehand, carefully organized and conducted promotional events are needed
• A “Road show” can be organized, during which the senior company’s representatives visit key financial centres and talk to potential major investors, revealing information necessary for the investment decision
• Sufficient advertising of the issue in the financial press
• Effective press conference before the issue with sufficient time to answer investors’ questions. Maybe organisation of company visits to key prospective investors.
• Brokers’ circulars – recommendations to investors regarding the flotation. If the company is successful in persuading brokers to issue them, there are reasonable chances that these circulars will be positive and favourable to the flotation.

5. Pricing decisions

5.1. Correct pricing of the issue.
Pricing is one of the major issues governing the success of an IPO. The issue price has a direct impact on the demand for the stock from prospective investors. If an issue was overpriced, the underwriter would not be able to sell all the shares, under priced and the company will not be raising as much money as it could. Although in theory pricing should be done through a formal valuation of a company, in practice a benchmark company is looked for and its P/E ratio is typically used.

Some other factors could also influence the pricing decision. A global study by Ibbotson, Sindelar and Ritter revealed that on average, IPOs were under priced by 15%. Underwriters say that a rising share price after the IPO subsequently makes it easier for the issuing company to raise further capital. However, it can be argued that underwriters are interested in a degree of under pricing just to be on the safe side and have better chances to place all of the issue. Therefore, in order to have a successful IPO, the company should actively participate in the process of defining its issue price and not just take the issue price recommended by its underwriter.

5.2. Some other pricing issues
Sometimes non-financial reasons are used in pricing. For example, during the flotation of CAP Group Limited in 1984, the company made a stock split 2:1 before the flotation to come to the price of £1.25 instead of £2.50. The major reason was that the closest competitor’s share price was £1.50 and without the split CAP’s shares would appear too expensive to investors .

It can also be said that a risk premium of around 20% in the first day’s trading is both acceptable and desirable to attract interest from the market, particularly speculative investors. However, it is only when the higher trading price is maintained over the next few months after the issue, in the absence of extraordinary events, that the issue price could be said to have been optimised in this respect.

2002.