Investment Banking For Dummies. Matthew Krantz

Going private would allow the company to make the necessary long-term investments (which short-term investors may not like) to make it more competitive in a world where mobile gadgets have become a big threat to traditional desktop computers and laptops. It worked. Dell returned to the public market as Dell Technologies in 2018 as a much stronger company.

      Understanding the unique traits of private deals

      IPOs may get all the attention. Splashy sales of stock to the public, such as ride-sharing company Uber Technologies in May 2019, grab headlines and investors sometimes line up to buy shares.

      But sometimes companies raise money in more subtle and private ways. One example of a way investment banking pairs up companies and investors, away from the prying eyes of the public, is with a private placement. In a private placement, a company can sell stock directly to investors even if there’s no public offering or shares listed on an exchange (a regulated marketplace for securities to be bought or sold). Companies may use private placements because they offer a few advantages:

       Lighter regulation: IPOs are heavily monitored by regulators. Every risk the company faces must be disclosed along with audited financials, meaning the books have to be studied by an accounting firm. But because private placements are not offered to the public, the securities don’t have to be registered with the Securities and Exchange Commission (SEC). This means the company and investment banks don’t have to jump through all the hoops to get the sale done.

       Limited to sophisticated investors: Private placements can’t be offered to the general public. Instead, they must be extended only to accredited investors (typically, professional investors like mutual funds or high-net-worth individuals). These investors are the ones who are supposed to know how to research risky investments, or have the wherewithal and understanding to take losses.

       Lower costs: Because a private placement doesn’t require as much regulatory oversight, the costs of putting out the offering tend to be lower. Fewer lawyers are needed because there are fewer documents to create. And there’s less cost associated with investment banking, because private sales tend to be smaller and don’t require the lining up of a massive group of investors to get the deal done.

      

Private placements may seem like a dream come true for companies. After all, who wouldn’t like having fewer regulators breathing down his neck? But private placements come with their drawbacks, too. Because these offerings aren’t made to as many investors, companies tend to get lower price tags on their stock than they would if they sold shares to the public. Academic studies show that companies that sell stock in private placements tend to be valued about 30 percent lower than public companies. There’s also a limit to the number of private shareholders a company can have (500) before it must register with the SEC. After a company accumulates more than 500 private investors, which includes employees who get shares of the company, it must file with the SEC. Triggering this rule was a big reason Google (now called Alphabet) conducted an IPO when it did, in 2004.

      Initial public offerings

      The IPO still remains one of the pinnacles of what a company can achieve in its early life. When a company sells stock to the general public for the first time, it’s a sign that the company has a compelling enough story that it can attract outside investors to buy a piece of the company.

      IPOs are a financial transaction that requires the heavy involvement of investment banks. You’ll read more details about these important deals in Chapter 4.

      In this section, you find out the basics of IPOs. In a traditional IPO, the investment banking operation gets involved very early. The investment bankers are critical partners in allowing a company to go public.

      The lifecycle of a company: When going public makes sense

When a company is young, financing can get pretty dicey. It’s not unheard of for very early investors to pay for equipment and salaries of employees with any money they can get their hands on. Charging up credit cards, hitting up family members for loans, and tapping retirement savings are all ways that an entrepreneur with the burning passion to start a company gets the process started. Starting a company takes a tremendous amount of money.

      If the company proves to be successful, the options for raising money, or financing, grows. Prior to going public with an IPO, a growing company may consider a few options to raise money, including the following:

       Venture capitalists: Venture capitalists are investors who pool money from other investors looking for very high potential returns, and are willing to suffer huge losses in the process. Venture capitalists take the money they gather, usually from large institutions like insurance companies or pension funds, and bet money by buying stakes of young companies that have great prospects. Although many of these bets don’t pan out, if the venture capitalists hit it big with a few of their bets, the returns can be enormous. You don’t need to invest in many Googles (which ultimately sold stock to the public in an immense payday for venture capitalists) to make the gambles worthwhile. Although venture capitalists can be a critical place for young companies to raise money, it comes at a steep price if the company pans out. The venture capitalists end up owning a big slice of the company, which reduces the ultimate payout for the entrepreneur.

       Bank loans: Commercial banks are in the business of lending to companies that need capital. Periodically, a bank may extend a line of credit to a small business, especially if the business is stable. Banks, though, tend to be skittish and won’t lend if there’s even a scent of risk with the company. Internet companies, which have little in the form of assets, for instance may be turned away for bank loans because there isn’t anything to be used as collateral.

       Crowdfunding: The idea of crowdfunding is very new but likely to become more important. Currently, an entrepreneur with an idea can use websites like Kickstarter (www.kickstarter.com) to explain to the public what her idea is and how much money she needs to make it happen. Consumers interested in making the product come to life are able to pledge a dollar amount on the crowdfunding site. As soon as enough money is raised, the company can use the cash to build the product. Crowdfunding is currently only a way for consumers to donate money to new businesses, not invest in them. Typically, these crowdfunding donors are given a token of appreciation for their contributions, usually early dibs on the product after it’s released. Currently, though, companies aren’t allowed to sell stock using crowdfunding. That’s changing though. The 2012 Jobs Act contains a provision that opens the future to the idea of stock-based crowdfunding where companies can sell stock to the public. The SEC is tasked with the job of allowing companies to raise money with crowdfunding, while protecting investors.For much more information on crowdfunding, check out Crowdfund Investing For Dummies, by Sherwood Neiss, Jason W. Best, and Zak Cassady-Dorion (Wiley).

      There may be options for companies not ready for an IPO to raise money. But at some point, the companies with the best prospects outgrow the venture capitalists, don’t want to pay the onerous terms of bank loans, or need more capital than can be raised casually. When these things happen, it’s time for the company to go public. Going public is a relatively long and costly process that requires preparing statements for regulators and investors, getting the company’s story out, and actually selling the shares.

IPOs tend to be lagging indicators, meaning investors are more willing to take a wager on a newly public company when the broader stock market is doing well. IPOs tend to ebb and flow quite a bit, as Table 2-2 shows.

TABLE 2-2 Number of U.S. IPOs, 2014–2018