Unless of course you're Google and expected to raise $36.6 billion, one would think raising $23.1 billion in an initial public offering (IPO) would be plenty respectable for a company that didn't even exist six years ago.
The Google whiz kids who seemed to do everything right on the way to building their renown Internet search-engine set out to revolutionize the IPO process with a Dutch auction. What they found out was that raising capital has a search-engine algorithm all of its own.
Irv DeGraw, finance professor at Washington College was quoted in an August 19, 2004 USA Today article titled "Whiz kids' blunders blacken IPO's eye" by Matt Krantz, as saying: "These are guys that made their own rules (in Internet search) but are finding out you cannot make your own rules when dealing with the public market."
Like the famed Google search-engine, which filters website content to determine a site's relevance to specified search criteria, investors too filter company content to judge the company's relevance to specific investment criteria. When a company fails to communicate a match with an investors criteria, the investor moves on to find other more fitting investment alternatives.
Investors use many sources to gather company content. Business plans, registration statements, annual reports, and so on. Especially important are one-on-one meetings and the company’s roadshow, a forum for company founders to explain their business plan to investors.
Failure to Communicate
According to media reports, Google's IPO process was at best messy – upsetting institutional and individual investors alike. Professional investors complained the company's management wouldn't give them details on their business plan to help them value the company's future performance.
In fact, many large investors said that the roadshow left more questions than it answered. In addition, the Securities and Exchange Commission, the watchdog for individual investors, delayed the company's offering because Google appeared to have violated certain IPO regulations.
Of course, every deal has its missteps. But for a deal to be successful, both parties, the company and the investors, must be happy with what they are getting. To an investor, this means getting sufficient information with which to make an investment decision.
"It's like grabbing at air," portfolio manager Linda Killian, at Renaissance Capital told USA Today. According to Killian, the vague roadshow forced her to make "assumptions with products they won't tell us about."
The USA Today also reported that many analysts left the roadshow worrying that the way management handled the IPO might be an indication of how they intend to run the company as a public company. "Look how they managed the IPO. Am I going to trust the same management team to run the company?" says Chris Johnson, director of quantitative research at Schaeffer's Investment Research.
Investor Confidence Gap
Google had predicted the IPO would sell for up to $135 a share, giving it a $36.6 billion market valuation on par with Yahoo, even though Google's last year revenues where 10% less than Yahoo's revenues. This valuation also placed Google’s worth ahead of several corporate giants like Ford Motor, McDonald's, Fedx, and Aloca.
More importantly, some analysts believe that the company would need to grow its revenues at an average of 30% per year for the next fifteen years and keep 32 cents of every sales dollar in profit. Aggressive targets when you consider that Yahoo, the leading Internet portal and Google's largest rival, has averaged less than 30% annual growth over the past five years.
Yet Google presented little evidence to support its initial $36.6 billion valuation. Creating an investor confidence gap whereby investors were unable to determine if an investment in the company would be any better or worse than other investment alternatives. This, plus other factors such as tech stocks being on the verge of entering bear-market territory the day Google’s auction began, resulted in a $13.5 billion shortfall in the company’s final valuation.
Lessons Learned
While Google’s attempt to revolutionize the IPO process with a Dutch auction was a noble goal, the company failed to abide by the three rules of effective communication: have something good to say, say it well, and say it often.
No matter if you're a start-up company raising first round financing or a hotly anticipated IPO like Google, take the time to figure out specifically what you do that makes your business uniquely different from your competition. Understand exactly how you are going to create more value for your stakeholders than your competitors, which specific customers you’re going to serve, and so on. Then, express your idea clearly and often.
If you don’t, you'll create an investor confidence gap – just as Google did – and miss a golden opportunity to maximize the valuation of your business and the amount of funding you raise.
Mike Elia is a chief financial officer and an advisor to venture capitalists and leverage buyout specialists. His business plan ebook "Business Plan Secrets Revealed” shows how to make your business the most appealing investment choice to venture capitalist, bankers, and other business investors. Click here to learn more about avoiding Google's pitfalls and many others.