The IPO of Internet Companies
The conventional reason for a company to become
public listed is to increase profits in the company. This is also the main
reason why dotcom companies become public listed. As publicity is very
important to a dotcom, acquiring a listing on the Index creates a centre
of attention for the dotcom. Competition is extensive in the Internet;
hence drawing more users is a very important fixation that has to be
focused on.
Up to the year 2000, it has become evident that when
a dotcom becomes public listed, its share price tends to soar to a high
value. Those who benefit the most from this are the shareholders with the
largest shares in the company. This group includes the founders and the
Venture Capitalists (VC).
Every company starts of with an idea that one or a
group people devise. This stage is much easier than the next, which is to
be able to implement this idea with the aim of a profitable future.
Attaining this required capital is the principal dilemma. So, they
approach a Venture Capitalist (VC). He is a person or a company that
helps, in an economic sense, a newly founded company with a supposedly
superior business idea. In return they get shares in that company. The
only reason why a VC invests in a new company is to make a profit from the
shares in that company. During the years 1996 to 1999 of the dotcom
market, it became evident that it was very lucrative to go hire VCs and
become public listed.
Before a dotcom company gets listed, it tries to
advertise itself, in an attempt to gain popularity and to capture the
attention of potential investors. Upon listing on the Index, the dotcom
normally only sells a limited number of shares. Typically approximately
only 30 % of the total shares in the company are issued. The founders of
the company and the VCs hold the rest of the company’s shares.
Normally before a dotcom company announces its IPO,
the demand for the company’s shares increase radically. An excessive
number of investors are interested in investing in the company but the
limited number of released shares is not sufficient to comprise for the
demand. As a result, the company’s share price increases rapidly,
directly after the release of the IPO. There are many examples of this.
One example is Theglobe.com (Web page design guide). The initial price of
one share in the Theglobe.com was issued at $9. This figured increased to
$63.5 (606 %) before the end of the first day’s trading, which was a
record. One has to ask the question if such a boom is justified on
economical terms and this will be investigated later.
It is difficult for an ordinary investor to acquire
shares in an IPO. Institutions purchase most shares and this is because
they hold some economic power that puts them in a position where they can
literally demand shares in an IPO. This causes a delay of several days
before the ordinary investor can acquire shares and at this point, the
share price would have increased relative to the initial price.
There is a law that states that the Venture
Capitalist and a founder of the company have to keep their shares for at
least 180 days after the IPO. This law was implemented to prevent
exploitation of the shareholders. However, after this period, the VC and
founders are free to do as they please with their share of the company.
The Venture Capitalist and the founders of a company naturally know how
well the company is performing. They are the insiders. As insiders they
know that they have several advantages to the ordinary investors, who are
the outsiders. Advantages such as having influence on the future
investments made by any ordinary investor. This means that the psychology
of the market, to some extent, can be controlled by the advice of the
insiders. Even though it is illegal to lie about a company’s
performance, is it possible not to tell the whole truth or to highlight a
particular issue/s. This is a very powerful weapon that the insiders can
utilise to increase the share price.
At the point when the Venture Capitalist and founders
of the company believe that the peak of the share price has been reached,
they sell their shares in the company. These shares had not been
obtainable previously on the market. Suddenly, twice as many shares are
made available and according to the law of demand and supply, the share
price drops. The Venture Capitalist, and occasionally the founders, has
reached the target. The whole procedure is repeated with another company.
In the market, remain shares that aren’t as attractive as before and as
a result many ordinary investors suffer the loss of capital. This is not
the case for all the dotcom companies but it has certainly been the case
for several of them.
The quantity of profits that the Venture Capitalist
made during the first three years of the Internet Era were tremendous and
as a result more people and companies have entered the Venture Capitalist
business.
Venture Capitalists have always been present, for
example Queen Isabella, who assisted Columbus economically, was said to
have had the characteristics of a Venture Capitalist.
In the mid sixties a more modern type of Venture
Capitalist came about. These were mainly businessmen who were primarily
investing their own money. These businessmen identified promising
businesses and demanded a share in the company that they financed.
One of these first businessmen was Arthur Rock
(inventor of the term Venture Capitalist) who in 1968 invested $ 300.00 in
Intel. In June 1999 was this stake worth $624 millions, which is an
increase of 300 times. It did not take long before these businessmen
realised that the Venture Capitalist market could be very profitable. As a
result, several venture companies were founded and one example of these is
Kleiner Perking and Seguoia Capital.
In the beginning of the 1990s Venture Capitalism rose
in popularity. But this time it was not only traditional Venture
Capitalist firms and institutions that invested in new businesses, but
also huge public pension funds and corporate investors like Intel and
Microsoft. Intel alone has invested nearly $ 3 billions in company
start-ups.
Another
kind of Venture Capitalist, the “Angels”, had entered the market. An
“Angel” is a person who invests personal money into start-up
companies. Despite the fact that although many Venture Capitalists hit
hard times after the PC crash in 1987, the Venture Capitalist business has
been very lucrative during the last decade or so. The estimated average
venture capital rate of return over the last 30 years has been an
incredible 23% annually.
As one can see, the Venture Capitalists have control
in the dotcom market. They are the insiders and they know the market well.
It is necessary for the company to hire an investment bank when it
wants to go public listed. The investment bank acts as an advisor and a
distributor, and is sometimes also known as the Underwriter. Upon reaching
a prospective offering, after negotiations and discussions, and
establishing it, the investment bank then acts as a middle-man between the
company and the general public (i.e. the investors). The investment bank
assures the company that all the shares will be sold at this established
price. If all the shares aren’t sold at the right price, then the
Investment Bank has to buy up the shares.
The Investment Bank takes a commission of
approximately 7% of the gained profits. Between 1992 and 1998, the total
amount of money raised by technology IPOs was $48.8 billions and during
the same time $59.5 billion was raised in follow on stock offerings. The
commission on these offerings that has been paid out to Investment Banks
was astonishingly close to $8 billion. From this, is it not hard to
understand why Investment Banks have a very high interest in undergoing
the public listing operations.
Yellow
line: Performance of the whole industry of the investment banks
Blue
line: Performance of the technology industry of the investment banks
Due to this huge increase in VCs and Investments
Banks (see graph above), the opportunity for a dotcom company to become
public listed has increased. As a result, money is also invested into
companies with irrational business plans and structure. This increase in
Venture capital has had a profound influence on the dotcom stock market.
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