The Art of the IPO

Facebook's first day trading on the NASDAQ

Summer was not kind to Facebook. It was harsher still to Goupon and Zynga. All three companies are new to the public markets. If you were to look to their debuts only, you'd be forgiven for concluding that going public is a raw deal. Each of their stocks, to put it nicely, got hammered between Memorial Day and Labor Day--the US holidays that bookend summer. The Dow, during the same period? It rose 5%.

Going public is as much art as science. And as with any art, discipline and finesse make all the difference between masterpiece and flop. So for every Facebook, Groupon or Zynga, there is a LinkedIn, Zillow or Michael Kors. Each entered the market last year. Today, all three have stocks that are up more than 100% from their offerings, more than 90% this year--levels of outperformance that every founder, CEO, management team, Board, underwriting group and investor hopes for from an IPO--keeping the romance of the stock market alive.

Diverse in size, stage of development, offering, share and governance structures, these six companies' deals yield a handful of do's and don'ts that can help others navigate entry to the public market--artfully.

  • Treat public market investors as valuable long-term partners.  This is the stock market's version of The Golden Rule. Applied wisely, it comes into play long before offering documents are filed, guiding every IPO decision--timing, structure, pricing and attitude. Its corollary: don't give public market investors the impression that they are being ripped-off--or that you hold them in contempt. Facebook and Groupon--and CEOs Mark Zuckerberg and Andrew Mason--are learning these truths the hard way. Facebook's missteps: timing (late), pricing (high), structure (complicated), attitude (aloof) and Groupon's: timing (late), structure (aggressive), attitude (nonchalant). LinkedIn, on the other hand? Flawless timing, fair pricing and professional attitude.  
  • Beware the lure of private share exchanges. SecondMarket--and private share exchanges like it--have proven to be both a blessing and a curse to venture-funded companies. Alternative liquidity platforms for early-stage investors, they have allowed companies to remain private for longer than in the past. While the cocoon of private ownership is comfortable, the result has been IPOs that come later in companies' growth cycles, leading to valuation tensions between the private and public markets and a sense among public market investors that they are being fed table scraps. This is one place where Zynga got things right. It banned SecondMarket from dealing in its shares a year in advance of its IPO. Better yet: go early, share the wealth, learn the markets' discipline. See: Zillow.
  • Make key corporate governance provisions easy to understand, communicate and manage. Five out of the six companies here have two classes of stock--Michael Kors being the exception. While the structure clearly hasn't hurt LinkedIn or Zillow, when the going gets tough, subordinated voting rights give investors one more reason to exit quickly. And Facebook's staggered lockup provisions? Confusing, messy. Keep it simple: one class of shares, equal voting rights, one set of lockup provisions. It's working out just fine for Michael Kors. 
  • Sell secondary shares judiciously. Primary shares are those sold by the company in its IPO. Proceeds accrue to the company and are used to fund growth, pay down debt and make acquisitions. Secondary shares are those sold by the company's founders, investors, senior management and board members. The more secondary shares sold in an IPO the higher the red flags raised, especially in smaller, younger companies. Zillow got this just right. Not only were no secondary shares sold in its IPO, existing venture investors doubled down, buying in at the IPO price. Smart move. 
  • Price confidently, but conservatively. When LinkedIn went public last year, its stock shot up over 100% in its first day of trading. And a cry went up in the business and finance press: the stock had been underpriced, the company screwed. I disagreed. To punctuate the point, Facebook's IPO is an unfortunate real life example of what happens when an IPO is overpriced. It is (much) better to underprice than it is to overprice. Should investors bid the stock up, the company can return to market with a follow-on offering--at a premium to the IPO price. LinkedIn did this. It is far more work to crawl back from a fall. (Compounding Facebook's pricing error? 67% of the shares in the deal were secondary. An overpriced offering full of secondary shares is a double disaster.)  
  • Underpromise. Overdeliver. In April, on top of a solid first quarter, Zynga raised its earnings outlook for the year. Just three months later during its second quarter report, it cut EBITDA projections for the year in half, dropping them from $400 million to $200 million. Ouch. The most important thing a company can do, once public, is execute. The second most important: manage expectations effectively.

It's regrettable that an IPO the size and import of Facebook's was a flop. Culprits are many. For those considering entry to the public markets, don't be put off. Markets are as forgiving as they are taxing. Since Labor Day, Facebook and Groupon shares are up over 25%, Zynga's, over 15%. The travails of all three companies have largely been self-inflicted. Learn from their mistakes and the others' successes. Follow the spirit of the guidelines here--pay attention to the details, think long-term, keep things simple and clear, be open, stay humble--and execute--you're far more likely to have a masterpiece than a flop on your hands.

My track record: Last year, I wrote articles on Facebook, Zillow, LinkedIn, and Groupon. I was  concerned about the risk inherent in Facebook's private deal, I thought Zillow's story wasn't snappy enough, LinkedIn's deal was priced just fine and Groupon was likely facing a struggle. I got three out of four--and I'm pleased Zillow proved me wrong. All of the articles I've written about IPOs are here

Photo: Keith Bedford for Reuters