An IPO vs A PIPE

Private companies dream of doing an Initial Public Offering (IPO). They see it as the fast track to the money they need to grow their company. Its the primary reason that most private companies go public in America. While the IPO underwriter makes lots of money, an IPO isnt a very good deal for the fledgling public company.

In 2005, the average cost to file a SB2 Registration Statement with the U.S. Securities and Exchange Commission (SEC) has risen to over three million U. S. Dollars. For private companies, with gross revenues of less than five million U.S. Dollars, the private company will lose money doing an IPO. The private company cant raise enough money in the IPO to offset the costs of filing the SB2 Registration Statement.

Doing an IPO puts the companys shares, sold to the public, into the hands of the Depository Trust Company. The companys public shareholders have claims through their brokerage firms on these shares held in the name of Cede & Company.

However, the public shareholders are strongly discourage from seeking ownership of their shares and a public companys attempts to go to a Cash Market for an IPO have always proven futile. The problem with the Depository Trust Company holding the Public Companys shares is that these shares, called the float, are used to sell short the Public Companys stock. The problem with short sales is that they significantly add to the Public Companys Investor Relations costs.

If you combine annual Regulatory Compliance Costs with Investor Relations Costs, most IPO Public Companies can expect an annual bill of at least US three million a year to maintain their public company status. To parody advice, reportedly given by Mr. Vanderbilt, "If you have to ask how much it costs to do an IPO and maintain your public company status, you cant afford it."

Private companies grossing less than five million U.S. dollars have only one practical option. Go public via an American backdoor and seek Private Investment in your Public Equity (PIPE). The SEC closed the Reverse Merger and Shell backdoor on July 19, 2005. There are several other ways to go public in the United States.

Each has its strengths and weaknesses. None of the backdoors allows the private company to do an IPO. The advantage to all of these backdoor options is their costs are below US$100,000. Ask your attorney, accountant or equity advisor about the option that would work best for your private company.

The people funding PIPEs are fund managers, accredited investors, experienced offshore investors or groups of experienced offshore investors. In theory, their PIPE financings are not closely regulated because they are believed to know more about what they are doing than public investors.

This is an assumption that is often untrue. Nor should a private company assume that the PIPE underwriters are honest. Many PIPE, offers from toxic convertibles to leverage stock deals, are outright swindles. Due Diligence should be the Prime Directive of any CFO seeking a PIPE financing.

PIPE financings are done at a major discount to the prevailing stock price of the public companys shares. The investors must hold their stock for one year. The holding period and simplicity of the Private Placement Financing justifies the discount. Keep in mind that the IPO underwriters, within NASD guidelines; usually earn about 23% of the money they raise.

This is a10% discount on the IPO share price, a 5% accountable expense, a 3% non-accountable expense and a 5% commission from the IPO clients. These underwriters can easily double their return by requiring that the IPO Company supply half of the investors for their companys IPO.

The Stock Market Mindset is "Profit Now." This goal isnt consistent with a vision of building a public company. If the insiders and PIPE people dump their shares on the public market, the investor relations costs will skyrocket and the company will be bankrupted in a few years.

For this reason, a company seeking a PIPE financing from an honest funding source should clearly determine the goal of the professionals offering the PIPE money. If their plan is to sell their position in a year, the company is buying a costly investor relations problem in about 18 months from the funding.

Unlike the public funding an IPO, the honest professionals behind PIPEs will at least be willing to listen to a better plan that increases their profit and justifies their risks. Doing an IPO ensures that most of the IPO buyers hope to quickly flip their shares. The publics goal is to sell at higher prices.

The Public Companys shares will be back into the Market within weeks of the IPO. The Public Company must pay to find the buyers for these IPO shares. The Public Companys dilemma ensures that Market Professionals will start to flip nonexistent stock into the Market as soon as the IPOs share price starts to falter.

IPOs work for major companies unconcerned about the underpinning stock game costs. A PIPE is the only workable strategy for private companies with limited money. It takes planning to do a PIPE right. But, for these average companies, there isnt an equity-funding alternative. CFOs should seek an advisor that knows the Markets reality in any PIPE search.


He has been the Managing Director of Beowulf Investments http://home.earthlink.net/