by Patrick T. Finegan, Stern Stewart & Co.
Journal of Applied Corporate Finance | Vol. 4, Issue 1 | Spring 1991 pp. 35-40

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11 companies are in the same business–the competition for capital. In most instances, the issues that predominate are measuring performance, identifying profitable investment opportunities, and securing capital for expansion. Although the context sometimes differs for a private company (fewer disclosure requirements, more concentration of ownership and control, and informal methods of resolving disputes), these issues are still central management concerns. Yet the very features often cited as the attractions of remaining private–less scrutiny and interference from outsiders, and a family orientation—frequently conspire to make the issues more confounding.

Consider the case of Microsoft, arguably the most innovative and successful high-tech company (of the 1980s. The company went public in March 1986, unleashing millions of dollars of hard-won value for its founder, Bill Gates, while fueling expansion for still greater value in years to come. So favorable was the market’s reaction that four other software issues followed in Microsoft’s footsteps. One would think, midst the fanfare and applause, that the financial scrutiny paid by management to the offering would have rivaled what they paid to their highly successful products.

On the surface, this appears to have been the case. Total transaction fees, including underwriters’ compensation, were about $4.6 million, or only 7.1 percent of the $65 million in primary and secondary shares sold. I say only 7.1 percent because that percentage is frequently higher, even for much larger offerings. (Bet Public, for example, incurred $2.8 million in exchange and listing fees alone on its $75 million offering, nudging total fees above 12 percent.) For much smaller offerings–those, say, less than $10 million–transaction costs can become stratospheric, consuming as much as 15 to 25 percent of the equity raised. It’s not surprising that fees become the thorn in an owner’s side when evaluating the prospect of going public.1

So Microsoft did a good job of monitoring expenses, but then missed the boat on pricing. The closing price of Microsoft’s shares on the day of offering was $28, a price that held firm for several weeks thereafter. Too bad their shares entered the market at only $21. The $22 million in underpricing (or 33 percent of the $66 million offered) dwarfed what Gates and Microsoft paid in fees (see Table l)–a fact that escaped the press amid investor jubilation.

But why pick on Microsoft? Studies by several leading finance scholars confim that the average first-day runup for all initial public equity offerings, excluding investment funds, is on the order of 15 and 20 percent, and that the standard deviation of these run-ups is between 35 and 40 percent.’ In layman’s terms, not only is underpricing on the order of 50 to 60 percent not unheard of, it’s statistically certain in one out of six public offerings. For very small offerings-those of companies with sales of less than $500,000-the average run-up exceeds 25 percent, the standard deviation 50 percent. Add 15 to 25 percent in fees and it’s little wonder so many cash-poor companies resist going public. Continue reading “Maximizing Shareholder Value at the Private Company” →

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