By: Joseph Goldy, AAMS®
While traditional initial public offerings continue to be the primary avenue companies use to raise money and have their shares listed on a major exchange such as the New York Stock Exchange or Nasdaq, the process is not without drawbacks. Other alternatives to bring companies to market have been tested over the years, such as Dutch auctions (Google, 2004), Direct Public Offerings and Special Purpose Acquisition Companies, or SPACs.
First IPO
Our first IPO in the United States took place in 1781 with shares of the Bank of North America and Bank of New York trading on the New York Stock Exchange. In 1906 Sears Roebuck & Co. went public with the help of Goldman Sachs.
Drawbacks to the Traditional IPO
Historically, there are two significant criticisms the traditional IPO process has faced. The first is the limited availability for the average investor to obtain shares of the largest and most successful companies.
The offering begins with the company looking to go public hiring an underwriter (e.g., Goldman Sachs, J.P. Morgan, Credit Suisse) who will help them through the entire IPO process culminating in a decision on an offering price which determines how much money the company raises.
For example, if a company offers 10 million shares at $20, then $200 million goes to the company, less the underwriter’s fees. At what price the shares begin trading the first day is decided by supply and demand prior to the stock opening to publicly trade. For the more popular IPOs, the shares will begin trading substantially higher than the offering price, which is when the retail investors can start purchasing them. Much of the general investing public is cut out from investing at the offering price through this process.
Another downside from the company’s perspective is the cost of the underwriting process. The fees collected from the brokerage firms can be substantial, usually ranging from 5% to 7%, according to IPOhub.org.
However, a more hidden cost is the amount of money left on the table from an underpriced offering. This mispricing could add up to millions of dollars of opportunity cost for companies and is often attributed to underwriters wanting to price the shares to allow for a first-day pop in price.
Direct Public Offerings
Because of these issues, Direct Public Offerings (DPOs) have become more prevalent in recent years.
With a Direct Public Offering, the underwriter (along with their fees) is essentially removed from the process since the company is not offering new shares on the market. Instead, they allow existing shareholders, such as corporate executives and early investors, to sell their shares directly to the public on a national exchange.
Benefits of a DPO
A significant benefit of doing a DPO is there is no lock-up period as with an IPO, which restricts insiders from selling their shares for a certain period, which usually ranges from 30 to 180 days. Ben and Jerry’s ice cream used a DPO in the 1980s, and more recent examples of successful DPO listings include Spotify and Slack.
Disadvantages of using a DPO
The downside to using a DPO is that the company is not raising any capital since they are not creating new shares to sell to the public; they are merely opening the market for existing shares. Additionally, the method works best when the company already has a nationally recognized brand since little marketing is being done.
Special Purpose Acquisition Company (SPAC)
A third method of going public, which has been around for some time, but only recently regained popularity, is the Special Purpose Acquisition Company or SPAC. A SPAC is creating a shell company, often referred to as a “blank check company” whose only mission is to raise money for a potential future acquisition.
The newly created SPAC will trade on the NYSE or Nasdaq and has two years to complete an acquisition within their targeted sector or industry. Should the company not find an acquisition candidate in the allotted time, the SPAC is liquidated. The invested money is returned to existing shareholders minus any administration costs of running the SPAC.
Going public using a SPAC is like a traditional reverse merger, but with some notable differences. SPACs are newly created shell companies with clean balance sheets and a competent management team already in place, actively searching for an acquisition target. In contrast, reverse mergers were done with existing companies that simply ceased operations and become defunct.
Benefits of Using a SPAC
SPACs are appealing since they are a less costly and faster way to bring a company public. The popular online sports betting site DraftKings recently performed a very successful SPAC merger, and the stock is up fivefold.
Yet, SPACs are not perfect, and as recently as the morning of this writing, SEC chairman Jay Clayton announced the need for more disclosures to the public by SPAC sponsors in the areas of incentives and compensation.
According to a paper published by Renaissance Capital in July, of the 222 SPAC IPOs since 2015, only 89 have completed mergers and taken a company public. About a third of those had positive returns through the time the article was published.
Since the concept of selling shares of a private company to the public began in the 1600s with the Dutch East India Company, the IPO process has always been a little imperfect. Time will tell if newer methods of going public, such as direct public offerings and SPACs, will continue to gain traction. Or, will the traditional IPO process and major underwriters continue to control this vast area of the market.
Author’s Bio
Joseph Goldy, CFP®, is a wealth advisor and CERTIFIED FINANCIAL PLANNER™ at Highland Financial Advisors, LLC, a fee-only fiduciary wealth advisory firm based in Wayne, New Jersey.
Joe specializes in working with newly independent women because of divorce or losing a spouse. He understands firsthand the value of having a clear financial picture pre- and post-divorce and a plan to restate goals as a single person. When he is not helping clients, Joe enjoys spending time with his two sons outdoors and volunteering to help raise money for Type 1 diabetes organizations.