I have spent a lifetime helping people who want to raise some capital for their businesses. It has never been easier and less expensive to do so. The JOBS Act took care of that.
Most companies, especially those who want to raise $10-$50 million or more, will use a standard private placement. Many more companies elect to raise funds in the private market every year than in the public market because it is easier and less expensive than a public offering (IPO).
The SEC has provided for a stripped-down version of an IPO under Regulation A+. It allows a company to raise up to $75 million from public investors. Reg. A+ is intended to allow companies to manage the offering themselves, without the help of a Wall Street firm.
Many of the people who encourage small companies to use Reg. A+ believe that going public is easy. Most of those people have never worked at a Wall Street firm.
When Wall Street takes a company public it rarely fails to raise the capital it seeks. Using Reg. A+ without a Wall Street firm to underwrite the offering has resulted in many companies failing to get the funds they seek. What is Wall Streets’ secret?
Wall Street starts with the idea that no one really buys investments, but rather people sell them. Wall Street is built on the efforts of thousands of top-notch salespeople and a top-notch support system.
Before any company goes public the investment bankers spend months getting it ready. Most importantly, they spend time introducing these companies to larger, institutional investors who will purchase a significant amount of shares in any public offering.
Dog and Pony
Those “dog and pony” shows help the company’s management address the questions investors want to ask. Some of those institutions and hedge funds will be guaranteed to make a profit. More on that below.
About a week before the offering goes live the underwriters will turn the offering over to the sales department. If a good stockbroker is trying to sell shares in an IPO, the conversation might go like this:
“Hello Charlie, this is Fred from Goodbroker and Company. I promised to call you when we had a red-hot IPO. We have one coming to market tomorrow.
The company is called the “Flavor of the Month” Co. It uses blockchain to treat erectile dysfunction. It is going to be a $20 billion global market in 5 years.
I spoke with one of the investment bankers who gave it two thumbs up. He expects it to be priced at $30 per share.
I also spoke with the research analyst who covers this industry and he says this stock will be selling for $45 by the end of next year. That is why this IPO is hot.
It’s a 10 million share deal. My office was only allocated 120,000 shares. I can try to get you 1000 shares if you say YES right now. You have $30,000 in your money market account waiting for a good opportunity to make money. This is it. Will you take 1000 shares? ”
A good stockbroker will have that conversation over and over until he gets to yes several times. Thousands of stockbrokers making thousands of calls will sell out the issue, every time.
And then the secret that never appears in the textbooks, the underwriters will sell more shares than they have to sell. “Over-subscribed” is the most important attribute ever assigned to an IPO. Wall Street firms do it all the time.
The conversation that will take place the following morning, after the offering closes, illustrates the point:
“Charlie, this is Fred. I was only able to get you 700 shares in the underwriting at $30 per share. They filled the remaining 300 shares in the aftermarket at $33 per share. You don’t have to take those 300 shares at that price. I can send them back to the trading desk. But the stock is already trading at $37 and like I said yesterday the analyst is predicting $45 per share. So please tell me you will do the smart thing and just keep those 300 shares.”
So all the shares get sold and the underlying company gets the funding it needs. After that, as the shares trade, the underwriters provide research reports and trading support.
You just have to follow the money, and the shares, to fully understand why it works and how it works.
This offering for 10 million shares was sold at $30 per share. On the morning of the underwriting, those shares were delivered to the accounts of the purchasers and the book closed. When the shares begin to trade, the first orders will fill the demand created by selling more shares than were available.
Retail investors who buy into an IPO tend not to sell it the same day. Those who do are frequently not invited to participate in the next IPO. To satisfy those customers who wanted to buy shares but were allocated less than they wanted, the underwriter needs to find a few large blocks for sale.
I referred to dog and pony shows where the investment bankers would assure institutional investors that by investing in the IPO, the institution would make money. But not always as you may think.
When an IPO is over-subscribed it means that there are more willing buyers in the market and few sellers. That will cause the price to shoot up quickly. That “pop” in the share price has value and is treated as just another tranche in the cash flow.
An institution that bought 100,000 shares in the IPO might be promised a quick profit of $ 3 per share for helping to fill those orders. Flipping those shares quickly might earn the institution a profit of 10%, with no risk to capital, in less than one hour. Hedge funds especially like to play this game.
By helping to provide market liquidity for the underwriter the institution will be allocated some shares in a better underwriting later on. Shares that it will want to hold and not flip.
Scratch My Back
Can you say “scratch my back”?
Many of the firms that advocate the use of Reg. A+ lack investment bankers, research analysts, and most importantly, stockbrokers who already have established relationships with millions of investors. Most of these firms cannot trade the shares or provide liquidity for an aftermarket.
Practitioners who advocate the use of Reg. A+ as a useful tool for corporate finance will need to demonstrate that these offerings attract enough investors to sell out the offerings every time. Nothing indicates that is about to be true or that the advocates of Reg. A+ are even moving in that direction.
When someone comes to me thinking that they want to go public using Reg. A+ I tell them to stick with Reg. D and do a private placement of their securities. They will save a lot of money upfront and are likely to have the investors’ funds in their account months sooner.
And just to drive home the point, as an attorney, I charge a lot less to walk a client through a Reg. D private placement and to prepare the necessary paperwork than any lawyer charges for a Reg. A+ offering.
If you want to go public and cannot emulate what Wall Street firms do to get your offering sold, stick with the private placement market. It is always a much better place to find the investors you need.
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