Releasing an Initial Public Offering (IPO)

You market, or are about to market, a unique service or product. Your business is up and running,  growing or in the incubator stage. In any case, you find yourself weighing the options for going public.

What Is an Initial Public Offering?

Offering shares in your company to the public for the first time is called an Initial Public Offering, or IPO. Creating an initial public offering will allow your team to obtain capital and ultimately expand the business at a much faster rate. The only companies that can initiate an IPO are private companies. This means that up until this point, there are likely only a few investors involved. Since it's the first sale of stock by a private company to the public, an IPO is often a significan milestone in the company's growth.

Proceeding with an IPO will likely spell major changes in the company with the sudden surge in funds and higher share valuation. For example, an IPO is sometimes used as a means of reducing corporate debt after a large string of initial investments. Furthermore, IPOs are also an effective tool to attract new employees that may be interested in stock incentives when searching for new work.

If you're wondering how or where to structure the best launching pad for your IPO, look no further than Delaware. Almost all IPOs since the 1990s have been launched under the framework of a Delaware general corporation. 

Releasing an Initial Public Offering

Before launching an IPO, the company will need to determine the value of the shares. Gauge how much capital you’re trying to generate, then, based on your company’s growth and outlook, try to determine a value that will attract investors and help you reach your goals.

The company management ultimately determines the final offering price for the shares based on professional feedback and market conditions. On the day of the IPO, the company's shares will begin trading on a public stock exchange, and henceforth, the business will be treated as a publicly traded company.

There are several good reasons why almost all IPOs are Delaware general corporations, and attracting investors may be the biggest one. Investors don't invest in "good ideas;" rather, they invest in tangible, measurable ownership of some of the profits that originate from the ideas. And investors want that tangible, measurable ownership in the form of stock.

Most IPO experts agree that, through its general corporation provisions, Delaware offers the most versatile and functional toolbox of stock structures. Stock choices such as blank check preferred stock, super-voting powers, stock options, stock warrants and shareholder agreements give an entrepreneur a number of avenues to attract investors.

Blank check preferred stock is one example. You can structure your company right from the beginning with an optional second class of stock that gives you the latitude to offer special deals to important investors. Preferred stock is very attractive to investors, yet it costs you very little to issue.

Preferred stock lets you negotiate dividend rights, the votes per share, the security interests in the company's assets and the potential to convert the preferred shares into common shares at a future date.

Below are just two examples of how preferred stock acts in your favor in an IPO.

Attracting an Investor

In addition to generating funds, taking a company public with an IPO is a great way to generate buzz around your brand and attract brand new customers. The sudden surge in sales after your company goes public can be used as a great bargaining chip to gain new investors

Suppose you have an investor or interested party who, for whatever reason, hasn't demanded stock in exchange for his or her investment, until now. This investor has put nominal sums into the business but now, on the verge of your IPO, wants a major percentage of the stock.

You can approach that investor and offer a very attractive deal. The terms you negotiate are up to you because, under Delaware law, you have the flexibility to strike a deal on terms agreeable to both sides. You might offer, for example, 100,000 shares of (preferred) stock at $10 each with the following preferred terms: 1) guaranteed annual dividend of $1.00 per share (thus guaranteeing a 10 percent return on his/her money); 2) no voting rights until the company goes public (thus you're not diluting your own power); and 3) the preferred stock would be convertible to 1,000,000 shares of common stock one year after the company goes public. Thus, you have offered this investor the prospect of a substantial return on his/her investment without diluting your ownership stake.

Visibility and Credibility

Going public can raise a company's profile and enhance its credibility in the market. Being listed on a major stock exchange can attract attention from media and investors, helping to build brand awareness and trust. Beyond that, this can help the business grow in the long term by attracting new customers. A publicly traded company will have a lot more visibility on the market, naturally bringing in all kinds of new consumers.

Keeping Control

If you've been very successful raising investor money before the public offering, you run the risk of having attracted so much money that your share of ownership shrinks close to 51 percent, at which level you barely control the company.

At that point, while you maintain majority control of the company, you issue 100,000 shares of preferred stock to yourself with the following preferred terms: 1) no dividends (thus avoiding investor objections); and 2) voting rights of 100 votes per share on all matters shareholders may vote on (thus solidifying your voting power even if you sell more than 50% of the common stock). Even if you continue to attract investment funds that further dilute your ownership percentage, you have granted yourself 10,000,000 additional votes, more than enough to offset the voting rights of the other outstanding shares. (Note: doing all this correctly almost certainly requires the services of an attorney well-versed in these matters.)

Other Key Elements

Why is it called "blank check preferred" stock? Because the transactions described above are both possible with the same class of preferred stock. So, too, are other transactions if you have issued enough preferred stock. You simply designate the stock into different series and make arrangements with investors as circumstances dictate.

If you already have the preferred stock authorized, you can issue it to the investor on a same-day basis and close the deal without a long escrow period (if doing so is to your advantage). The "blank check" reference stems from the fact that you are issuing pieces of paper as you go along, as many as necessary, as long as investors accept them, in order to generate funds.

Another important point for IPOs is a basic tenet of Delaware corporate law: in a Delaware general corporation, the Directors set the price of the stock. This means that the price of your stock is set by what the Directors say it is worth and what investors believe it is worth, regardless of what actual value (capital or assets) underlies the stock. The investors are betting on the future success of your company, and their judgment as to the future value of your company is what sets the share price, both when you sell it initially and when it trades on the open market.

Most investors, however, don't make bets on the value of your stock without keen insights and a vast storehouse of knowledge about how your business will fare on the open market. Ultimately, their appraisal and the appraisals of many other experts will determine the value of your stock.

How Much Stock?

A key issue you should resolve before you form your Delaware general corporation is the number of shares of stock to issue.

The answer lies in asking these two questions: 1) how much money do I need to raise? and 2) what percentage of the company's stock (ownership) am I willing to give up for that amount of money?

Like so many other business calculations, you really have to back into the number of shares you need by using the answers to the above questions. Let's say you want to raise $100,000 in the first year, then a second private offering of $1,000,000 the second year, then an IPO for $25 million after three to four years. For the first offering, you've decided you'll give up 10% of the company for the initial $100,000, and another 25% for the second offering of $1 million. So you'll be giving up 35% before you go public.

By that simple calculation, you would retain 65% before your IPO. However, going public is rarely that simple. Assume you'll need to devote some stock, or stock options, to attract top personnel. Also assume that other needs will consume more of your ownership percentage. Many companies can bring in highly experienced employees under the promise of stock options or discounts on public stock. This underscores the importance of blank check preferred stock. As your ownership percentage of common stock shrinks, you can retain majority voting rights (and control) with provisions of preferred stock that you specify. The balance you want to achieve is attracting investors and talented employees while avoiding the prospect of being voted out and losing control of the company you built.

When you've determined the amount of money you need to raise, you'll then have to decide the number of shares and the value of each in order to reach that number. The calculations involved in those decisions are affected by variables too numerous to mention. Please note: You need to seek the advice and assistance of experienced counselors if you are serious about going public.

Remember that ideas hatched in college dorm rooms or products invented in a garage have led to public companies worth billions of dollars. It has to start somewhere, and Harvard Business Services, Inc. can help you form your own Delaware general corporation, structured and ready to go public, for less than $600.

*Disclaimer*: Harvard Business Services, Inc. is neither a law firm nor an accounting firm and, even in cases where the author is an attorney, or a tax professional, nothing in this article constitutes legal or tax advice. This article provides general commentary on, and analysis of, the subject addressed. We strongly advise that you consult an attorney or tax professional to receive legal or tax guidance tailored to your specific circumstances. Any action taken or not taken based on this article is at your own risk. If an article cites or provides a link to third-party sources or websites, Harvard Business Services, Inc. is not responsible for and makes no representations regarding such source’s content or accuracy. Opinions expressed in this article do not necessarily reflect those of Harvard Business Services, Inc.