Getting portfolio companies there and beyond
The last several months have seen both a significant increase in international appetite for initial public offerings in the U.S. by Chinese companies, as well as some increasing wariness given recent disclosure issues that have arisen in connection at least one recent offering. Companies such Linktone Ltd., which Morrison & Foerster LLP represented in its global IPO and continues to represent in ongoing compliance and corporate work, have recently achieved high profile listings on Nasdaq or the New York Stock Exchange.
In this environment, it is important for the board, management and in-house legal counsel of private companies planning their IPOs, or of public companies thinking of spinning off and listing one or more subsidiaries, to consider the basic elements which lay the groundwork for a successful IPO. Equally important, but sometimes overlooked in the excitement of the IPO process, are the practical implications of being a U.S. public company in the long-term and how these issues can impact companies' overall goals and resources -- and indeed affect the value at which a post-IPO exit for investors may be achieved. The following summarizes some of the key issues at the pre- and post-IPO stages that we have seen arise in our recent work.
Venture capitalists play an important advisory role during this process since they are often in a position (as board members and/or significant shareholders) to focus company management on these issues.
The obvious goal of any IPO is to complete the process in as short a period of time as reasonably possible, while concurrently preparing public disclosure documents that are complete and accurate to minimize any potential liability. Achieving this goal is often complicated by a number of IPO "hot buttons" which active venture capitalists can help company management to focus on and overcome early:
Completing a successful IPO on Nasdaq or the New York Stock Exchange is always an exciting time for a company -- the prestige of having made it on a high profile stock market, the press coverage and, most of all, the cash the company is suddenly sitting on to expand its business. But before a company formally initiates an IPO process with underwriters, legal counsel and accountants, it should give serious consideration to how it will maintain industry interest in its stock and maintain significant liquidity. Venture capitalists, particularly those with investment banking experience, are an important source of advice (through its board or shareholder status) on how a young company can seek to avoid the pitfalls of becoming a small cap stock with little liquidity.
Specifically, companies need to be aware that there is a growing "orphanage" in the U.S. public markets, populated by companies whose valuation is below the necessary threshold to command the attention of investment bank analysts, and, as a result, institutional buyers, whose trades typically comprise the majority of trading volume for most companies listed on Nasdaq and the New York Stock Exchange.
A company whose stock is "in the orphanage" is in a difficult situation. The expense and nuisance of public registration and burdensome ongoing disclosure requirements is not counterbalanced by genuine liquidity or an accurate trading price which real liquidity would bring. Moreover, a thinly traded stock tends to trade down. Stock that came public at a share price of, say, $15, once fallen into the orphanage, may slip into single digits even though the company is doing just fine. This can lead to ever-declining stock prices and trading volume which, in severe cases, may result in delisting.
We have seen companies follow this downward spiral, including a few which have bounced back dramatically such as NetEase.com, an Internet portal operator in China and a client of our firm. NetEase.com went from an IPO price of $15.50 to subsequently trading under $1 on Nasdaq and facing potential delisting in 2002, to trading well over $40 in recent quarters and the initiation of analyst coverage by several investment banks.
To stay out of the orphanage, a company's management and board should be ready to commit themselves for the long-term to not only growing the company and meeting analysts' expectations, but also to: