WHAT WERE THE MAIN MOTIVES FOR MAKING THE IPO?

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Theoretical Framework

In this chapter we present the theoretical framework that will be the platform when conducting our study. The different financial markets will be described briefly before penetrating deeper into the theories of IPOs and buy-outs. The summary at the end of the chapter will list the advantages and disadvantages with both alternatives, as well as linking the theory with the research questions that will be used in the empirical study.
In order to clearly follow the disposition of the Theoretical Framework, we have chosen to present the chap-ters in Figure 4 below.

Financial Markets

In this chapter we will explain the two different financial markets discussed throughout the thesis; the public equity market and the private equity market.

Public equity market

A public equity market, or stock exchange, has a number of characteristics according to Arnold (2002). The stock exchange is a market place where ‘fair-game’ takes place, i.e. in-vestors and fund raisers are not able to benefit at the expense of other participants – all players are on ‘a level playing field’. Further, the market shall also be regulated to avoid abuses and frauds, as well as it shall be reasonably cheap to carry out transactions. There shall also be a large number of buyers and sellers in order for effective price setting of shares and to provide sufficient liquidity. (Arnold, 2002)

Private equity market

The private equity market, according to Fenn, Liang and Prowse (1997), is an important source of funds for start-up firms, private middle-market firms, firms in financial distress, and public firms seeking buy-out financing. Further, the authors explain, the private equity market can be organised into two sub-levels; organised private equity market and informal private equity market. The organised market consists of professionally managed equity investments that acquire large ownership stakes and take an active role monitoring and advising the portfolio companies. The informal market, on the other hand, is characterised by insiders remaining the largest and concentrated group of owners, i.e. ownership is not concentrated among outside investors.

Differences between Public and Private Equity Market in Short

Before penetrating deeper into describing IPO and buy-out, a brief summary is presented in Figure 5 in order to clarify the different main characteristics for public and private eq-uity.

IPO

An initial public offering (IPO) will make the earlier private corporation a public corpora-tion and there will be several issues to deal with compared to the private market. Most of them we will handle in the following sections.
In this thesis we will only cover the Stockholm Stock Exchange (OMXS), and we denote that all stock exchanges around the world are different from each other. At the Stockholm Stock Exchange there are two different listings possibilities; first is the A-list that is for companies with higher turnover and it has higher demands on firms that want to be listed. The other is the O-list that covers the rest of the publicly listed companies, with fewer de-mands and companies with smaller turnover. (OMX, 2006)
According to Petty, Bygrave and Shulman (1994), an IPO alternative is only for a few en-trepreneurial ventures. There are many listing requirements along with direct and indirect costs, which in hand may be inconvenient or uneconomic for most entrepreneurs. In the following chapters central themes such as motives, valuation, requirements and perform-ance will be covered, in order to explain the nature of an IPO.

Motives for IPO

There are many different motives for making an IPO; we will cover some of the most common to give the reader an understanding of the advantages with an IPO. Grundvall, Melin-Jakobsson & Thorell (2004) describe a variation of general motives that are to be presented below.
The raising of capital: The stock exchange (e.g. OMXS in Sweden) is a part of the capital mar-ket. They provide a market for risk capital, the so called secondary market where “second-hand” shares are traded. One of the most common reasons for going public is to gain ac-cess to this market, hence expand a company’s capital due to issuing new shares. Further, many high-growth firms are often constrained financially and need a new way to acquire capital. Along with this, there is a time difference between the time of investment and the time it takes to generate capital, therefore debt financing may not be suitable. According to this an IPO may be a better alternative, since you evade debt financing (Huyghebaert & Van Hulle 2005).
Publicity: By going public, the company will be analyzed by financial institutions, media, and several other entities, which will make the company and its business operations more known. This can have positive businesslike advantages, but if it is handled badly there is a chance for incorrect interpretations and negative spreading of rumours about the company.
Status: When a company goes public it usually raises the status of the company, especially rewarding towards international companies and media. It can somewhat be seen as a “sign of quality”.
Recruitment possibilities: Many companies have seen an advantage when recruiting staff after an IPO. The reason is surely somewhat psychological. The challenge and stimulation with a continuous external interest, is to many people a positive factor. This motive goes hand in hand with the motives of publicity and status.
Ownership for employees: One motive could be that possibility to make employees owners of the company. The company can through different ownership-programs offer the employ-ees part-ownership. For a person who believes in the company and in him-/herself, a posi-tive personal dividend can be obtained.
Generation change: An IPO can help to solve problems with a potential change of genera-tions. The heirs of family, whose fortune lies primarily in a company, may have completely different interests and plans for the future. An IPO facilitates the possibility to divide the ‘fortune’ without having to break up the company or sell it in its entirety.
According to Arnold (2002) there could also be other motives that may be essential to the shareholders, and for future investments.
For shareholders: Shareholders benefit from the availability of a speedy, cheap secondary market if they want to sell. Not only does the public market give the possibility for the shareholders to sell their shares, it also gives them a value of their shares within a reason-able degree of certainty. By contrast, unquoted companies’ shareholders often find it diffi-cult to estimate the value of their shares.
Mergers and acquisitions through own shares: After an IPO, a company has the possibility to ac-quire other companies through paying the whole sum, or a part of the sum, with their own newly issued shares. After the company has gone public, every share is set at a price. This price, multiplied with a number of shares can represent the sum or part of the sum in a merger or acquisition. This kind of deal is directed to the acquired company’s owner, and the owner has to agree to such deal before it is attainable. Also needed in this kind of deal, is the approval of the shareholders of the buying company. The own share will be diluted when investing with own shares.
According to earlier empirical researches there are a few additional motives for going pub-lic, or at least some other aspects of above stated motives.
Dispersed share ownership: In a public firm, the required capital is created by selling shares to a large number of investors. To compare this with a private firm where external financing of-ten is generated by one large investor (or small group of investor). Two positive reasons of having a public firm with a large number of investors are; (i) the presence of numerous shareholders, all with smaller holdings, imply a much better diversified owners structure (ii) the avoidance of a large investor, with considerable more bargaining power towards the en-trepreneur, to interfere with the entrepreneur’s business strategy. (Chemmanur & Fulghieri, 1999)

Valuation of IPOs

According to Kiholm and Smith (2004), there are several methods of valuing a firm. The different methods to use depend in what stage a company is situated in, what risks that is involved in the IPO, and what legislation that is present in the country. Different opinions of a firm’s worth can also play a big role when considering an IPO. The company will be valued by analysts, who will look at balance sheet, income statement and cash flow of the company, and then decide the value of the company.
The issuing of shares helps the company to raise capital through selling the shares. By sup-plying freely tradable shares to investors, the IPO set off the public market for the shares and allows the “market” to establish a value of the equity. The procedure of going public starts with that a company selects an underwriter, normally an investment bank, that ad-vices, issues, distributes and underwrites the risk of market price fluctuations during the of-fering. This is the primary valuator of the company that also serves as a good ground be-fore an IPO, even though it is not always accurate in their valuation when compared to the final offering prices. When an underwriter determines the value of a firm it looks to value the enterprise on a pre-money basis, i.e. before the IPO proceeds but reflecting the oppor-tunities facing the venture. This will be a comparison of firms in the same industry or re-cent pricings on similar companies. After that, the underwriter arrives at an estimate of an equity market value. Having done this, the underwriter will determine the number of shares to be offered, and the price per share based on estimate of existing value per share. (Ki-holm & Smith, 2004)
According to Lowry (2001), IPO volume is positively related to firms’ demand for addi-tional capital and the level of investor sentiment. The author also claims that when tempo-rary overvaluations of companies occur (a common occurrence when PE companies are involved in pricing), the volume of IPOs also is increased.
According to Wiggenhorn and Madura (2005), miss-pricing of newly public firms may be affected due to liquidity and/or information during the first year after the IPO. This comes from the fact that they have not shed any information up until the IPO, and their liquidity is limited because they have not yet secured financing at the early stage. The miss-pricing phenomenon varies among the three different periods. In the first period the owners or managers have inside information but are not allowed to sell. Investors’ overconfidence about private information causes an overreaction to the price, and for that reason miss-pricing may be present. In the second period miss-pricing is present since private- and pub-lic information increases, and analysts cover the firm more actively. In the third period, a miss-pricing may be present due to the owners’ sell-out of shares. To sum up, a newly pub-lic firm experiences both changes in liquidity as well as a change in both public and private information. This is due to the underwriter’s efforts to stabilize the share price, and how investors respond to the information.
According to Hebb and MacKinnon (2004), there is also an increased risk of under-pricing of a public company when a commercial bank acts as an underwriter instead of an invest-ment bank. This is due to the presence of a greater degree of asymmetric information in the after-market. It has been discussed that the reason for this comes from a potential con-flict of interest faced by commercial banks, since they may place their own interest before their customers’ interest.
Also noticeable is the fact that the issuing firm is rewarding the underwriter for the services they achieve, e.g. they are paying fees. It is however important to recognize that the in-vestment bank is also selling the securities to their customers. Thus, it becomes unclear as to what is driving the pricing decision by the investment banker. There are empirical evi-dences that investment bankers tend to under-price new offerings to the disadvantage of the existing shareholders. (Petty et al., 1994)

Preparations and Requirements for IPO

We will now cover the preparations and requirements before and after the IPO, and we will start with the different aspects a company has to go through before making an IPO.

Before the IPO

The chronology of an IPO is relatively straightforward according to Petty et al. (1994):
The owners and management decide to go public
An investment banker is selected to serve as underwriter
A prospectus is prepared
The managers, along with the investment banker, goes on the road to tell the firm’s story to the brokers who will be selling the stock
On the day before the IPO is released to the public, the decision is made as to the actual offering price
The shares are offered to the public
This is not as easy as it sounds; it comes with numerous other complications. It is also said that a shift in power arises during the process. As of the time of the prospectus has been prepared, and the firm’s management are on the road show, the investment banker gets more control of the decisions. After that the demands of the marketplace starts to take over, and the market decides the final outcome. (Petty et al., 1994)
To be able to make a planned IPO, the company has to be well prepared to avoid difficul-ties to make the IPO in due time. It takes approximately three months to complete an IPO after an application for admission to the stock exchange. Before the formal application is completed, issues have to be handled and demands have to be met. This takes time, and a firm should count on roughly one to two years of preparations before the formal applica-tion. (Grundvall et al., 2004)
Kensinger, Martin and Petty (2000) mean that to go public takes a lot of energy and time from the management and is often experienced as a distraction to the ordinary business. It results in a reduction of managerial focus and a decline in performance. Further, the au-thors mean, it also implies uncertainty to the employees when being set out to a new owner, which may result in lower morale due to the stress and anxiety. Owners and em-ployees with a lower morale will often result in decreased earnings which is very bad to a company just about to go public. According to a research by Petty et al. (1994), the IPO process is considered one of the most shattering and annoying, but still the most motivat-ing and exciting experiences the management have known. In a survey, the CEOs who had participated in the IPO procedure had spent on average 33 hours per week on IPO-related work for over four and a half months.
According to Grundvall et al. (2004), there are several requirements that have to be fulfilled before going public.
Legal due diligence: Before a company makes an IPO, it has to be inspected by an external commercial lawyer. The reason for this is to show whether it exists possible obstacles to the IPO and to verify that the whole picture is given of the company and its business.
Education: A company has to send their Board of Directors, management team and ac-countants to go through training in order to create an understanding of the demands the stock exchange has on each listed company.
Record (A-list only): If a company wants to be listed at the A-list it has to show a historical record of operations conducted the last three years and be able to show accounting docu-ments. There are no specific demands if a company wants to enter the O-list. However there exists a demand of non-financial information so that the investors can make an ap-propriate valuation of the company.
Documented earning capacity (A-list only): To enter the A-list a company needs a record of profit earning. The profit has to be comparative to other firms in the same industry. For both lists an inspection of key ratios will be conducted. The purpose with the inspection is to examine if the company has a stability and profitability according to the stock exchange. The company has to show sufficient financial resources for the upcoming twelve months after the day of the IPO.
Market value (A-list only): If the company would like to be listed at the A-list they need a market value of at least 300 Billion SEK. There is no such demand for listing at the O-list.

Table of Contents
1 INTRODUCTION
1.1 BACKGROUND
1.2 PROBLEM
1.3 PURPOSE
1.4 DEFINITIONS
2 METHODOLOGY
2.1 QUALITATIVE APPROACH
2.2 DEDUCTIVE APPROACH
2.3 PRIMARY DATA COLLECTION
2.4 VALIDITY, RELIABILITY AND GENERALISATION
3 THEORETICAL FRAMEWORK
3.1 FINANCIAL MARKETS
3.2 IPO
3.3 BUY-OUT .
3.4 THEORETICAL DISCUSSION
4 EMPIRICAL FINDINGS & ANALYSIS
4.1 WHAT WERE THE MAIN MOTIVES FOR MAKING THE IPO?
4.2 HAVE THE STATUS AND/OR THE PUBLICITY OF THE COMPANY CHANGED SINCE THE IPO?
4.3 DO YOU THINK THAT THE MARKET NORMALLY MAKE ACCURATE VALUATIONS OF PUBLIC COMPANIES?
4.4 WHAT WERE THE DISADVANTAGES OF MAKING AN IPO?
4.5 ARE THERE ANY DISADVANTAGES OF BEING A PUBLIC COMPANY?
4.6 WERE ALTERNATIVES TO IPO DISCUSSED?
4.7 WOULD THE PREPARATIONS TO SELL TO A PE COMPANY BEEN DIFFERENT THAN MAKING AN IPO?
4.8 PREMIUM PRICES ARE OFTEN PAID WHEN TAKING A PUBLIC COMPANY PRIVATE (SEE RECENT BID ON GAMBRO). WOULD NOT THE COMPANY THEN BE VALUED HIGHER PRIVATE THAT PUBLIC?
4.9 CAN THE COMPANY VALUE BE AFFECTED BY WHO THE SHAREHOLDERS ARE?
4.10 HOW DID THE OWNERSHIP FOR THE MANAGEMENT TEAM CHANGE WITH THE IPO?
4.11 HOW WOULD THE MANAGEMENT TEAM VALUE THE SIMPLICITY OF BEING PRIVATE, I.E. BE SPARED FROM PUBLIC DEMANDS?
4.12 IF THE SHAREHOLDERS FACED THE SAME SITUATION AGAIN, WITH IDENTICAL CONDITIONS, WOULD THE SAME DECISION BE MADE, I.E. MAKE AN IPO?
5 CONCLUSION AND DISCUSSION
REFERENCES
GET THE COMPLETE PROJECT
Why Are IPOs Still Attractive? A comparison between going public or staying private