The upcoming Shake Shack IPO highlights an increasingly festive atmosphere in today’s IPO market, and smaller businesses are being invited to the party. There were more IPOs in 2014 than in the past 14 years, and the average size has decreased, indicating a growing appetite for smaller deals.
“The IPO market is more accepting of companies that, it doesn’t matter the size, but they better be earning money,” says Kathleen S. Smith, principal at Renaissance Capital, which manages IPO portfolios for newly public companies. “Or they need to have growth and show a path to earnings.”
Small businesses considering an IPO exit strategy should start planning early, while revenues are still small. (Shake Shack itself had only $20 million in revenue for 2010.) Here, we offer a primer to help evaluate whether an IPO is right for your business, and if so, how to do some early staging to attract attention and ensure a smooth process.
Is an IPO for Me?
Smaller businesses have two primary exit strategies for getting value out of the company: sell or go public. Considering an IPO requires evaluating several factors, including whether or not you plan to hand the business over to an heir or other family successor. Going public can be a way to always have highly valued shares available for funding growth, making acquisitions or rewarding employees, but there are significant challenges to running a public company. You can’t do the due diligence too early—planning exit strategy options should be part of any business plan.
What’s the IPO Process?
There are five main stages to an IPO, with more complex mini-processes within each step.
- Hire an underwriter/bank.
- Do due diligence and valuation, spearheaded by the bank.
- File and amend the company prospectus.
- Do a road show for large potential investors across the country.
- Calculate final pricing and share allocation, right before trading opens.
This five-step process usually takes six to nine months, but that doesn't include the advance preparation that many companies do before signing on with an underwriter.
How Can I Start Planning Now?
No matter what size or stage of development, every company considering an eventual IPO can benefit from two important (and free) steps: Look at “comps” and talk to investment bankers.
Real estate brokers establish housing prices based on comps, or comparable listings, and IPOs work the same way. The experts will be comparing you to similar companies in your industry, so go ahead and do a deeper dive on your competitive benchmarking. What companies in your industry are going public, and what have they done? Do they have profits and/or earnings? How are investors valuing them—what are the key factors?
For example, Shake Shack is estimating a $1 billion valuation on its current $84 million in revenues. It has shown massive growth for a 10-year-old company—this type of growth and scale are two attributes that investors tend to drool over.
The second step IPO-bound companies can take is to talk to investment bankers now. Take advantage of free advice to find out what your strengths and weaknesses are, and learn more about what the IPO process would look like for your company. Meet with enough banks to form your own checklist of what criteria you want in an underwriter.
What Do Underwriters Look For?
Companies that have accepted venture capital may have a leg up on an IPO, as those investors usually insist on public-company type business management. These factors help ensure that a company has trustworthy controls in place:
- Outside board, comprised of not only investors and company principals but industry experts and seasoned business managers
- Succession plans designed to keep the company stable during transitions
- Experienced accounting firm
- Corporate attorney overseeing company operations and paperwork
- Not many transactions among company insiders
- Transparency via clear and reliable financial statements.
An underwriter will also thoroughly examine certain factors to help establish a company’s financial potential, and therefore its IPO value. These include:
- Growth (historical and potential)
- Potential for stock liquidity.
In other words, act public before you go public. “Get yourself into the posture,” says Smith, and the sooner the better.
Even if you ultimately pass on an actual IPO, setting up for one will help your company develop a strong business plan and reliable management controls. An IPO isn’t for every small business, but today’s public markets seem friendlier than ever to smaller deals. If you're curious about this potential exit strategy, now is the time to learn more.
Read more articles on IPOs.