How to Take Your Company Public, Part 1: Rituals.

In December of 2013, we took KindredBio public. We incorporated in September of 2012, so in a span of 15 months, we went from a standing start to a NASDAQ listing. At the time, it was one of the fastest biotech IPO in biotech history.

In this article, I will explain how we did that, why we did that, what we did well and poorly, and what you should think about when you take your own company public.

The Public Market Chooses You, You don’t Choose It

When we started the company IPO wasn’t the plan.

The pet industry was slow-moving and underappreciated, but with tremendous potential. There was almost no competition. We felt confident that we could stay under the radar, and botstrap our way to success slowly. We planned to raise a modest amount of money — perhaps $10–20 million, and build a billion-dolar company that was still owned mostly by the founders.

But then, the biotech market burst open, and Pfizer spun off Zoetis. The way Pfizer spun off Zoetis was that they gave their shareholders some of the shares. Public market investors who knew nothing about the veterinary market were forced to bring themselves up to speed on the field because they had to decide whether to keep the Zoetis shares.

When they did the due diligence, they realized that the veterinary market was so much more attractive than human pharma. The end result was that Zoetis stock traded at higher multiples (valuation as defined by stock price per dollar of earnings), which meant that the market cap of Pfizer plus Zoetis was greater than the market cap of the combined company prior to the merger.

All of a sudden, investors started looking for more public veterinary companies to invest in. This led to Aratana going public and doing well.

At that point, we knew we had to go public. Our reasons were as follows.

First, we could no longer stay under the radar. Slow and steady wouldn’t work. We realized soon there would be other veterinary public companies — both from spinouts and from IPOs — and the field would accelerate. We could no longer count on walking alone through the orchard, picking off the low hanging fruit at will. There were going to be other apple-pickers filling the orchard. We needed to fill our coffers and accelerate our programs. We had to run.

Second, the cost of public market capital became sharply lower. It suddenly became lot cheaper to tap into that source than private sources or to rely on reinvested earnings.

Third, I had run a public company before. That meant that I had the skillset and the network I could tap into, lowering the risk of being a public company. Being a public company (vs. private means) greater and faster access to capital, and frees you from being beholden to VCs. But it is also more expensive (legal, accounting/SOX, D&O insurance) and you have to manage thousands of public investors, and can be a significant drain on senior management. It’s not a decision to be taken lightly. Previous public company experience on the management team (especially for the CFO role)is an important relevant factor, both to company’s success and investor confidence (and their willingness to invest).

We were also aware that IPO window opens and closes, and that if we wanted to set sail, we had to do it when the tide was in.

This is the first lesson for IPOs: the timing of IPOs and whether to go public is more a function of the public market forces rather than the company. Going public shouldn’t be the goal. IPO is one option among a variety of options (including partnering), and when the conditions and cost of capital makes going the right choice you should take it. If Nordstrom is having a sale and you can get shoes from them cheaper than from Amazon, buy some.

Now, what do I mean when I say the IPO window was open? By that, I mean that investors are willing to buy into an IPO.

And what makes investors willing to buy? Typically, it’s when IPOs are “working” by which people mean that newly public companies’ stock goes up after the IPO. When people see newly public companies’ stocks rise, then more people buy into other newly public companies in expectation of profits, and it becomes a self-fulling prophesy. This results in a positive feedback loop.

Of course, the reserve is true as well. When IPOs “don’t work” then the cycle unwinds in reverse and the IPO window slams shut.

In fact, the biotech IPO window had been firmly shut for some time until May 2013, when Receptos wnet public and did very well. That opened the window wide. As an aside, my understanding is that Receptos went public because they had been unable to raise private funds from VCs, furthering my point above that external factors and availability of capital drives funding strategies and IPOs.

Now, IPOs is one part financing, one part business, one part storytelling, and one part ritual. Let me start with the ritual part.

What I mean by that is that there are certain steps you traditionally take, and certain checkboxes investors expect you to tick. In an IPO, large sums of money trade hands between parties that don’t know each other, and especially with biotechs, there is a lot of risk.

That means that when investors look at you, the company management, they want to be reassured that you know what you’re doing. They’re funding an expedition into the jungle to bring out the ancient gold artifacts. They want you to know what you’re doing, and to look like you know what you’re doing. If you’re wearing fluffy bunny slippers and carrying a brown bag lunch as you’re going into the Amazon, that’ not going to make them want to give you millions of dollars.

So apart from the business case, which I will get to later in this post, you need to go through the ritual properly.

Step one, you need a banker. Well, you need one for legal reasons as well (I am going to get to that too), but mostly you need one for ritualistic reasons. And you need the best banker you can get.

The best banker can get you in front of the best investors, the ones with the most money and the ones with the best street cred. Ideally, you want the investors with both, but if you have to choose, you want to choose the ones with the cred.

That’s because in each industry, there are small number of investors who are considered by their peers to be the smartest. In biotech, they’re the ones often staffed by MD/PhD from Harvard/Mass General Hospital or ex-Merck or Genentech people, who have the best records. Many investors follow the “smart” money. And generalists certainly follow these bellwether investors. These are the investors you want “on your cap table” (list of investors that you have on your capitalization table).

In fact, during your presentations, one of the most frequent questions you get will be “who else is investing?” Much of investing is heuristics and pattern recognition. Investors often will figure that if the bellwether investors who are smart and do thorough due diligence are investing, then it’s probably a good bet.

The investors also know that the best companies can get the best bankers, so they will react very differently if JP Morgan or Goldman brings them a company, versus another lesser-known bank.

Now, how do you know which banks are the best banks, and how do they get that way? The best banks are known as bulge bracket banks, ostensibly because in the “tombstones”, or announcements of the deals, they are listed at the top of the list of banks. The list changes over time, but the current one includes JP Morgan, Goldman, Morgan Stanley, Bank of America, Citi, Barclays, and UBS according to this site. The true top tier banks can vary a bit from industry to industry, since some banks are more active in some industry than others.

And how do banks get to be top banks? How are they ranked? To some degree based on deals they do, but mostly based on the order in which they’re listed on IPO documents. Really. That’s it. And how is the order determined? 90% based on how the banks are ranked, and 10% on the massive infighting they do during the offering. In other words, banks are ranked highly if they are listed first on IPO docs, and they’re listed first if they’re ranked highly. See what I mean by rituals?

My advice: try to stay out of it. They will fight tooth and nail and drag you into the fight on where they are listed on the document, the font size, margins, spacing. I’m not kidding. Stay. Out. Of. It. Thank me later.

Generally, you will have several banks helping you on the IPO. Bigger the IPO, more banks you have. More banks you have, more investors you will talk to and more money you will raise. Not.

You actually only need one bank to raise the money. The other banks are for analyst coverage — more banks mean more analyst coverage (they can’t promise coverage because of SEC rules but usually this is the case). Ideally you would want like 20 banks on your IPO but you can only slice the IPO fees so many times before it becomes too small.

There are disadvantages of going with top tier banks though if you’re doing a small offering. They will pay much less attention to you than their bigger clients. In fact, sometimes the second bank listed will end up doing all the work. You may hire a top bank, and they will get the top billing and the lion’s share of the fees. That bank will bring in a lesser known bank, with the understanding that the other bank will do most of the work.

So the first step for an IPO is a bake-off between the interested bankers. They will come and give a presentation to the board, and after a series of them, the board will make a decision on which bank to go with.

As I said, apart from signalling to investors that a good bank thinks the company is worthwhile, there isn’t a lot of difference between the quality of service they provide. And the part that does make a difference is not the investment banker part — the bankers you interact with has one main job: get the listing. They are there to manage the company. The part of the bank that interacts with the investors, the part that is far more important, is the equity desk, and their salespeople. They’re the ones who generate demand for your stock and manage the demansd.

In addition to a good bank, you also need to check a few other boxes. You need an experienced CFO, typically with public company experience. The investors want to know you will be able to comply with SEC and SOX requirements, and that you will be able to finance the company properly. Good CFOs can be difficult to find, and they’re expensive. And you don’t need a public company level CFO unless you’re going public. So you will often recruit one shortly before the IPO.

Ideally, you will also want credible previous investors and august people on your board of directors. And… you also ideally have a reputable accounting and law firm. You can use any Public Company Accounting Oversight Board (PCAOB) sanctioned audit firm for your audit of course, but some investors may look askance at that. We found that was very rare (your banker may fret more about that than investors). The difference in quality between top tier and second tier law firms and accounting firms is not much, in my experience, except for complicated or rare or mission-critical matters, but the fees are. We’re talking about 10% difference in quality for 300% difference in price. If they’re just filing boilerplate SEC documents, there is no difference in quality. For mission-critical matters like IP ligtigation though, you wil get 5000% difference in quality for 300% difference in price. You have to decide for yourself whether saving couple of millions of dollars per year is worthwhile.

The official kick-off for the IPO is an org meeting with all parties (management, banks, lawyers, accountants, etc.) where you will review the timelines, division of labor, etc.

To summarize, for you safari, you need good guides, plenty of supplies, appropriate clothing, etc. This is the second lesson: you need to follow the rituals if you want to avoid spooking the investors.

Now, there are also legal reasons for bankers, lawyers, and accountant that go beyond ritual needs of course. In days of yore, before SEC existed, anyone could sell stock to anyone else. Sort of like crypto today.

After the disaster of 1929, new rules were instituted, and now a company can’t typically sell shares directly to the public without using a bank. (There are some exceptions like crowdfunding.) So when you do an IPO you’re selling shares to the bank, not investors. The investors are buying the shares from the underwriting bank. And if something goes wrong, they are supposed to turn to the bank for redress.

It used to be that the banks would hold the company shares for a days or weeks before they eventually sold them, and would take on the risk that the shares may not all sell, but those “bought” deals are rare (except for convertible debt). Typically the banks hold the shares for a few hours.

I don’t want to make this post too long, I will discuss the remaining topics, like the business model, S-1, SEC, roadshow, and pricing, in future posts.