Rude VC: Intro to IPOs: US vs. France

May 15, 2012
Vote on Hacker News

If you’ve been reading the French press recently, you are no doubt aware that this week represents the start of a new adventure… I’m of course referring to the imminent road show for Facebook’s IPO.

 Already affecting a billion people on the planet, and probably 100% of RudeBaguette readers, Facebook strikes me as the perfect trigger to kick off a discussion on this blog about IPO’s, specifically their role in European venture-backed technology startups. This post represents the first installment of a multi-part series on the topic.

Today we’ll first discuss a few IPO basics, and in a later post touch on the specific implications for our market here.

This is only the beginning…

One could be forgiven for viewing the IPO event as an end goal. The media encourages this notion by reporting on the ‘home run exits’ for the VC’s, or on the newfound wealth of company founders and early employees, as if now they all hit the jackpot and are taking all their chips off the table. But like the first word in the I.P.O. acronym, the IPO event is really more of a beginning than an end for a company and most of its stakeholders.

An initial public offering is the first sale of stock by a company to the public. A company can raise money by issuing either debt or equity (the joke in France is that there’s a third option: subsidies). Anyway, when raising money via equity, a company can tap accredited investors (e.g. VC funds, high net worth ‘sophisticated’ individual investors, or other institutions and corporations); or additionally, a company can offer shares to the public markets. When restricting its equity issuances to a limited number of accredited investors, the company remains private. In the latter case, the company takes on the new status of public company, begins trading on a public stock exchange, and becomes subject to a new regulatory framework, governed by the SEC in the U.S. (the AMF in France) designed to protect public investors.

Pros and Cons

The Wikipedia entry on IPO’s discusses the fundamentals in more detail, but in summary the rationale for a company to consider going public can encompass the following:

  • Strengthening and broadening the equity base
  • Starting the process of creating liquidity for the initial shareholders
  • Attracting and retaining employees through equity on a liquid market
  • Facilitating future access to capital and creating new financing opportunities
  • Exposure, prestige and public image
  • Facilitating acquisitions

And of course being public can entail any number of drawbacks:

  • Significant legal, accounting and marketing costs
  • Ongoing requirement to disclose financial and business information
  • Meaningful time, effort and attention required of senior management
  • Risk that required funding will not be raised
  • Public dissemination of information which may be useful to competitors, suppliers and customers
  • Increased pressure on short-term financial performance

Process

The process of going public typically involves one or more investment banks which are known as “underwriters”. The company going public enters into a contract with the lead underwriter to sell its shares to the public. In a song-and-dance routine dubbed the “road show,” the underwriter approaches investors with an offer to sell the company’s common shares. Upon selling the shares, the underwriter(s) keep a commission based on a percentage of the value of the shares sold.

In addition to investment banks, and because of the wide array of legal requirements, IPO’s typically involve one or more law firms with a deep practice in securities law.

Public offerings are sold to both institutional investors (such as mutual funds, or in France, SICAV’s and even tax fund management firms) and to retail customers (the general public, e.g. widows and orphans). Because of the tendering of shares to the general public, the process is closely regulated. For example, in France a company going public must obtain two steps of authorization from the AMF, and publish a detailed prospectus (‘document de référence’) while adhering to a variety of deadlines and notice periods.

Following the road show and compliance with all regulatory requirements, the underwriter sets a deadline for the investment commitments from the institutional and retail investor groups. At some point almost in parallel, the company and its advisors will likely choose one of two primary ways of setting the price of the shares being sold: either i) by announcing a fixed price, or ii) by going through a process of ‘book-building’ in which the underwriter attempts to gauge investor demand for the IPO and thus determine the most appropriate price which will ensure the fundraising target amount is met.

If and when the targeted fundraising amount is attained, the IPO operation will generally be deemed a success. The underwriter often is allowed to increase the size of the public offering by up to 15% under certain circumstances (known as the ‘greenshoe’ option).

The investment bank underwriting the IPO will often also initiate research coverage on the company so that their corporate finance department and retail division can attract and market new issues.

Stock Exchanges

Finally, a word on the public markets. The stock exchanges with some minimum degree of pan-European exposure that would be relevant for a French company are:

  • Euronext (which in France includes the Alternext and the Marché Libre)
  • OMX (headquartered in Stockholm)
  • London Stock Exchange and AIM
  • Deutsche Börse

Additionally, practically every European country boasts its own stock exchange (Borsa Italiana, Helsinki Stock Exchange, etc.) which generally is more appropriate (and often restricted, even) to listings in the home country.

We’ll elaborate on these points further in the context of European tech companies in a future post.