340 ◾ The Guide to Entrepreneurship: How to Create Wealth for Your Company
15.4.2 Disadvantages
There are several well-known counterbalancing pressures against going
public. Among the major disadvantages are:
◾ High initial cost of going public
− Underwriters’ expenses
− Road show expenses
− Legal and accounting expenses
◾ High cost of compliance
− Audit expenses
− Burdensome regulations (Sarbanes-Oxley)
− Periodic reporting requirements (10Qs, 10Ks).
− Annual shareholder meetings
◾ Shareholder pressures
− Increased quarterly earnings
− Unrelenting pressure to increase quarterly share price
◾ Distant and unsympathetic shareholders
15.4.3 The Going Public Process
At rst, management should seek the advice of attorneys who understand
the complexities of securities law, independent public accountants experi-
enced in public offerings, and investment bankers to advise on how to best
position the company.
Established companies must present (1) audited nancial statements
for the past ve years (or two years in the case of smaller public offer-
ings), and (2) selected nancial data going back ve years. Auditing rms
evaluate the company’s internal report system and its accounting practices
to ensure conformity with Securities and Exchange Commission (SEC)
requirements.
The auditing rm should also determine whether the company’s
accounting system could produce the required nancial statements for
timely reporting once the company becomes publicly held to help under-
writers, investors, or lenders gauge the company’s current operations and
its potential.
Harvesting ◾ 341
15.4.4 The Registration Process
The process of going public is governed by the SEC Act of 1933, which (1)
requires that a registration statement be led with the SEC before securities
are offered for public sale, and (2) prohibits the sale of any securities until
the registration is declared effective. It is virtually impossible for a company
to sell its own securities directly to the public. Instead, this is handled by
underwriting syndicates that maintain current investor lists and worldwide
ofce networks. Table15.1 summarizes the steps typically included in the
registration process.
Table15.1 Registration Process Steps
Underwriter Selection Selection of lead underwriter that will
form the syndicate that will buy the
company securities and resell them to the
public.
Company Evaluation Underwriter evaluates the management,
products, and markets to determine the
marketability of the stock. Often,
problems are encountered that must be
corrected prior to the offering.
Letter of Intent Preliminary and nonbinding agreement
that estimates the size of the offering, the
price range, as well as details of
commissions and expense reimbursements.
“Quiet Period”
(The period of time extended from
the time a company les a registration
statement with the SEC until SEC staff
declares the registration statement
effective.)
During the time the SEC “reviews” and
“comments” on a potential registration,
the SEC discourages initiation of publicity,
issuance of forecasts related to revenues,
income, or earnings per share, and the
publication of opinions concerning
valuations.
Drafting the Registration Statement Prepare Form S-1 or Form SB-2 consisting
of (a) the offering prospectus for eventual
distribution to investors and (b) any
supplemental information required by
SEC.
(Continued)
342 ◾ The Guide to Entrepreneurship: How to Create Wealth for Your Company
Table15.1 (Continued)
Registration Statement Filing Ofcial ling with SEC. At this point, the
information contained becomes a matter
of public record.
“Red Herring” Before the Registration Statement
becomes “effective,” copies of the
preliminary prospectus or “Red Herring”
are distributed by the managing
underwriter to the syndicate.
Due Diligence Meetings The underwriters typically conduct an
investigation to ensure that the
registration statement does not contain
misstatements or omissions of material
facts using the Red Herring.
At this point, company ofcials submit
themselves to formal probing by
underwriters, attorneys, and potential
investors during Due Diligence meetings.
Compliance with “Blue Sky” Laws Individual states may impose laws
different from U.S. federal laws; these are
called “Blue Sky” laws. The company must
ensure that the registration complies with
all applicable federal and state securities
laws.
Deciency Letter After reviewing the registration statement,
the SEC may issue a “Deciency Letter” if
issues need to be addressed or revised
before the statement can become
effective.
Offering Price, Size
plus “Green Shoe”
Company and underwriters agree on the
price and size of the offering based on
preliminary interest by potential investors.
The underwriters may also enter into an
option known as a “Green Shoe” to
acquire and resell an additional 15% of
stock under a rm commitment to cover
overallotments to customers.
Harvesting ◾ 343
15.5 Strategic Alliances
“You have to break a few eggs to make omelets.”
Strategic alliances represent a way for aggressive companies to pursue
growth by broadening product lines, penetrating new markets, and stabiliz-
ing cyclical businesses despite limited resources.
A strategic alliance is an agreement between two or more parties
to pursue a set of agreed upon objectives while remaining independent
Table15.1 (Continued)
Comfort Letter Auditors and attorneys issue a “Comfort
Letter,” a long and complicated document
required by the underwriters. The
document details the accountant’s
viewpoints and concerns on a variety of
accounting issues and nancial matters
appearing in the prospectus.
Effective Registration Statement When the SEC declares that the registration
is “effective,” the company and
underwriters sign a formal and binding
letter of agreement.
Publishing the Prospectus The “Prospectus” is the part of the
effective registration statement used as a
selling document distributed by the
underwriting syndicate for distribution
to prospective investors. It is a lengthy
document detailing information about
the offering and the history of the
company, including exhaustive nancial
information.
Closing Meeting Final meeting to make the exchange of the
securities for the proceeds of the offering.
At this time, the underwriters purchase
shares and begin reselling to the public.
Is There Life After an IPO? For the company founders, a smaller slice
of a rapidly expanding pizza is worth more
than a larger slice of a smaller pizza.
This is the entrepreneur’s “pizza
philosophy.”
344 ◾ The Guide to Entrepreneurship: How to Create Wealth for Your Company
organizations. This form of cooperation lies between mergers/acquisitions
and organic growth.
3
However, the exchange of managerial talent, resources,
capabilities, and possibly an equity investment elevates the alliance beyond
a mere contractual agreement. The three main characteristics of strategic alli-
ances are summarized next:
◾ Multifaceted, goal-oriented, long-term partnerships between two companies
◾ Both risks and rewards are shared
◾ Typically leads to long-term strategic relationship
15.6 The “Big Question”
Before embarking on any strategic alliance quest, management must answer
the “Big Question”:
◾ Do we create organic sales growth vs. sales growth through acquisitions?
The rm can grow organically (by internal investment) or inorganically
(by strategic alliances, i.e., cooperative ventures, joint ventures, joint owner-
ship, or mergers and acquisitions). One theoretical way of approaching the
“Big Question” is to look at the continuum of strategic partnership interde-
pendence as shown in Figure15.5.
When two or more companies combined participate in a project, it is
a cooperative venture. This participation can be in the form of sharing
nancial or technical resources for mutual benet.
A joint venture (JV) creates a separate entity in which both rms invest.
The JV agreement species investment rights, operational responsibilities, vot-
ing control, exit alternatives, and the allocation of risks and rewards. The entity
could be a division or an entirely new business established for the venture.
In a joint ownership alliance, the parties agree to long-term licensing
agreement, co-marketing agreements, co-development agreements, joint
IPO advantages
Improved financial condition
Using stock for acquisitions
Using stock as employee incentive
Investor liquidity (exit)
Enhanced company visibility
Figure 15.5 Strategic alliance option—Strategic alliances may be a protable way of
growing the company rapidly.
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