An IPO vs. A PIPE

An IPO vs. A PIPE
By
William Cate

Private companies dream of doing an Initial Public Offering (IPO). They see it as the fast track to the money they need to grow their company. It's the primary reason that most private companies go public in America. While the IPO underwriter makes lots of money, an IPO isn't a very good deal for the fledgling public company.

Costs vs Returns

In 2005, the average cost to file a SB2 Registration Statement with the U.S. Securities and Exchange Commission (SEC) has risen to over three million U. S. Dollars. For private companies, with gross revenues of less than five million U.S. Dollars, the private company will lose money doing an IPO. The private company can't raise enough money in the IPO to offset the costs of filing the SB2 Registration Statement.

The DTC Trap

Doing an IPO puts the company's shares, sold to the public, into the hands of the Depository Trust Company, a privately owned firm. The company's public shareholders have claims through their brokerage firms on these shares held in the name of Cede & Company. However, the public shareholders are strongly discouraged from seeking ownership of their shares and a public company's attempts to go to a Cash Market for an IPO have always proven futile.

How the Trap Works

The problem with the Depository Trust Company holding the Public Company's shares is that these shares, called the float, are used to sell short the Public Company's stock. The resulting short sales significantly add to the Public Company's Investor Relations costs. If you combine annual Regulatory Compliance Costs with Investor Relations Costs, most IPO Public Companies can expect an annual bill of at least US three million a year to maintain their public company status. To parody advice, reportedly given by Mr. Vanderbilt, "If you have to ask how much it costs to do an IPO and maintain your public company status, you can't afford it."

The Only Option

Private companies grossing less than five million U.S. dollars have only one practical option. Go public via an American backdoor and seek Private Investment in your Public Equity (PIPE). The SEC closed the Reverse Merger and Shell backdoor on July 19, 2005. There are several other ways to go public in the United States. Each has its strengths and weaknesses. None of the backdoors allows the private company to do an IPO. The advantage to all of these backdoor options is their costs are below US$100,000. Ask your attorney, accountant or equity advisor about the option that would work best for your private company.

PIPE Funders

The people funding PIPEs are fund managers, accredited investors, experienced offshore investors or groups of experienced offshore investors. In theory, their PIPE financings are not closely regulated because they are believed to know more about what they are doing than public investors. This is an assumption that is often untrue. Nor should a private company assume that the PIPE underwriters are honest. Many PIPE, offers from toxic convertibles to leverage stock deals, are outright swindles. Due Diligence should be the Prime Directive of any CFO seeking a PIPE financing.

Discounts and Costs

PIPE financings are done at a major discount to the prevailing stock price of the public company's shares. The investors must hold their stock for one year. The holding period and simplicity of the Private Placement Financing justifies the discount. Keep in mind that the IPO underwriters, within NASD guidelines; usually earn about 23% of the money they raise. This is a10% discount on the IPO share price, a 5% accountable expense, a 3% non-accountable expense and a 5% commission from the IPO clients. These underwriters can easily double their return by requiring that the IPO Company supply half of the investors for their company's IPO.

The Flawed Mindset

The Stock Market Mindset is "Profit Now." This goal isn't consistent with a vision of building a public company. If the insiders and PIPE people dump their shares on the public market, the investor relations costs will skyrocket and the company will be bankrupted in a few years. For this reason, a company seeking a PIPE financing from an honest funding source should clearly determine the goal of the professionals offering the PIPE money. If their plan is to sell their position in a year, the company is buying a costly investor relation's problem in about 18 months from the funding.

A Better Plan?

Unlike the public funding an IPO, the honest professionals behind PIPEs will at least be willing to listen to a better plan that increases their profit and justifies their risks. Doing an IPO ensures that most of the IPO buyers hope to quickly flip their shares. The public's goal is to sell at higher prices. The Public Company's shares will be back into the Market within weeks of the IPO. The Public Company must pay to find the buyers for these IPO shares. The Public Company's dilemma ensures that Market Professionals will start to flip nonexistent stock into the Market as soon as the IPO's share price starts to falter.

Where IPOs Work and Where They Don't

IPOs work for major companies unconcerned about the underpinning stock game costs. A PIPE is the only workable strategy for private companies with limited money. It takes planning to do a PIPE right. But, for these average companies, there isn't an equity-funding alternative. CFOs should seek an advisor that knows the Market's reality in any PIPE search.

He has been the Managing Director of Beowulf Investments [http://home.earthlink.net/~beowulfinvestments/] since 1981 and is the Executive Director of the Global Village Investment Club [http://home.earthlink.net/~beowulfinvestments/globalvillageinvestmentclubwelcome/]
You can email Mr. Cate at: Beowulfinvestments@Earthlink.net