With all of the news surrounding recent IPOs like Groupon, Yelp, and Facebook, it is easy for us to forget the larger picture: There are significantly less IPOs now, then there were 10 years ago, and the market for initial public offerings has effectively been slow. The IPO market has changed in the past decade for a number of reasons. Most importantly, there are simply less IPO underwriters now than there were before. Major players in the IPO space such as Hambrecht & Quist; Alex, Brown; Robertson Stephens and Montgomery Securities have either merged or been consolidated into larger banks than focus on larger deals. This focus on larger deals means those underwriters are no longer interested in the smaller initial public offerings and do not bother doing investment research on small-cap companies. We can see this shift to larger deals clearly. In the 1990s, the average deal size for a NASDAQ IPO was $35 million, while in 2006, this figured ballooned to $115 million. Additionally, the average market cap for these companies went from $55 million in the 1990s to $330 million in 2006. Today, the IPO market has no interest in companies that are strong and growing but could be valued at less than $250 million.
The inability go public to raise equity can prove quite a challenge to these small but growing companies. Luckily, however, there is an alternative – aptly named, an alternative IPO. In an alternative IPO, a company often completes a reverse merger and uses PIPE financing. In a reverse merger, a public entity “acquires” the stock of a private company in exchange for about 90% to 95% of the shares of the public entity. The newly merged company then takes on the name of the private company and installs the private company’s management.
Once the company has effectively gone public through a reverse merger it often uses PIPE financing to actually raise the capital it seeks. A private investment in a public entity (PIPEs) is typically structured to allow an investor to purchase stock at a discount to the market price making it often highly lucrative for investors. Furthermore, the speed of PIPE financing makes it highly desirable for the companies.
In an always-changing market, we need to understand some of the underlying market dynamics. Alternative IPOs provide an intriguing opportunity for both companies and investors alike.