An IPO

In the last offer-- in the last video, not the last offering. I guess it was a bit of both. We had completed our Series B. We had gone back to the till. Got another round of venture capital funding. And we raised $10 million more that's going to help us build out the website and do some marketing, and hire up some more engineers and other employees. And to do that we had to sell one million shares. We essentially sold them at $10 a share. And so after that offering, well, our pre-money valuation was $30 million and our post-money is now $40 million. That's the value of our assets as-- I mean, the website, that's kind of an arbitrary valuation. And I've gotten a letter asking, well, how do you value that? And that's a whole subject for another playlist. And I will do that. I will do a whole playlist on valuation, eventually. But, to get there, the first thing to understand is just the capital structure and how capital markets work in general. So that's what we're doing here. But anyway, so after you got the $10 million-- you had $30 million before, you get $10 million, your post-money is $40 million. And we had to issue a million extra shares to do it. So before the money we had three million and now we have four million shares. So let me draw what our balance sheet looks like. So we had $1 million and then we raised $10 million more. So if we look at the left-hand side of our balance sheet, we have $11 million in cash, and we have our website and intellectual property. Maybe we have some patents now. So you can say assets of the firm. I guess you could say non-cash assets, right? That's cash. And some of them could be intangibles, like branding. Or maybe we made some small acquisitions of other people. And we'll do more videos on actually the mechanics of acquisitions and all that. But you get the idea. These are all of the other assets of the firm, whatever they may be. And then on the equity side, because we have no liability, so in this case assets will be equal to equity. On the equity side of the equation we just have four million shares. 1/4 went to the Series B guy, 1/4 went to the Series A guy. He had bought a million shares, I think it was at $7.50 a share. Then the angel investor had given us a million shares at, and I think it was $5 a share, that was the angel. And then there's me and my buddies, we split the last, that first million shares five ways. And if I wanted to draw my sliver, I still have my 200,000 shares. And we could keep doing that. We could get a Series C and a Series D that will keep us going. But let's say that a couple of other people have decided to sell socks on the internet. And we realize this is becoming a very competitive space. And we really want to just lay down the gauntlet. And make sure that ours is the dominant player. Because we figure that whoever gets the biggest market share fastest, is going to become the Amazon.com and everyone else is going to turn into these me-too players and they're all going to go out of business. So size has benefits in this situation. So we don't want to do these piddly $10 million offerings and $20 million offerings. We want to go big time. We say, you know what? We're going to expand our company huge, we're going to push marketing hard. And so we want to raise a lot of money. Let's say-- let me make up a number-- let's say we want to raise, I don't know, we want to raise $50 million. $50 million to invest in the business and do some hard-core marketing. And it happens to be at a time-- let's say it's 1999. The stock market is racing ahead. People would love to get in on this kind of stuff. So we say hey, let's do an initial public offering. And then that has two benefits. One, we will be able to raise a lot of money for the firm to invest in maybe building distribution centers or the marketing that I talked about. And the other side benefit, which we won't really talk about much at the board meeting, but all of these people right now, they're all holding these shares, right? I have these 200,000 shares. This angel investor has this million shares. And there's really not a lot they can do with them, right? Maybe the angel investor, maybe he had an expensive divorce settlement and he has to make some alimony payments now, and he doesn't really have the cash. He can't do anything with these shares, right? Same thing with these VCs. These VCs are accountable to their investors. And they can say-- like, this VC can say oh, you know what? I bought those shares at $7.50 per share, and then this guy came and bought it at $10 per share, so I already got a 33% gain on my investment. But the investors aren't that impressed by that, because you're still holding the shares. You can't really say they're worth $10 until you actually turned them into $10. Or you turn them into actual cash. So, by doing an initial public offering, all of a sudden all of the players will have liquidity. Which means they can exchange what they have, including myself. So they can exchange what they have for actual cash if they need to. So how does that work? So I would go to an investment bank, although they've all turned into commercial banks now. But we're talking in a pre-2008 world. I would go to an investment bank and I'd say-- or more likely they would come to me and say hey, you guys could raise big money in the public markets right now. Why don't you do an IPO? And in a few seconds you'll realize why they are so keen to do it. And I say, sure. We can raise a lot of money. And also we'll be in the press, so that'll be free marketing in and of itself. So I say sure, do all of the work. So what they'll do, is there will be a lead underwriter. Let me write that down, lead underwriter. And that's essentially the person who does all of the legal work. They're going to file documents with the SEC that describe the company. And they're going to make models and projections and all that. And then they're also going to have people riding along with them, other banks. And they're going to form a syndicate. A syndicate is just a group of banks that work together to kind of handle a larger transaction than any one of them would be willing to handle by themselves. And it kind of spreads the risk amongst them. So the bottom line is what the banks do, other than doing all the legal work. They'll value the company and then they'll go to all of their clients. So all of the people who trade through that bank, all of the institutional clients, all of the hedge funds that have their prime brokerage accounts at those banks. And just so you know, a prime brokerage account is just like a brokerage account, but it's a brokerage account for big guys. It's a brokerage account for people managing $100 million and not their E-Trade account. That's all a prime brokerage is. And they'll go to these guys and say hey, we have this hot IPO issue, socks.com. And we've done our models, and we think this is a $5 billion market. We think that this company is worth-- we think this company is worth at least $100 million in its current form. So once again realize, I mean, even though we're kind of doing something a little different now, all of the other things were essentially-- you could call them private offerings. Or private placements in some way. Essentially these were private equity sales. And I know that word is used a lot, private equity. And that's what venture capital essentially is. Although normally when people talk about private equity, they're not talking about venture capital. And I'll do a whole other video on that. But venture capital fundamentally is private equity, right? Because these shares that you're selling, they're not traded on a public exchange like the New York Stock Exchange or the NASDAQ, or something like that. So anyway, back to what we were doing. These guys, these banks, they go to their clients and say hey, I have this hot new issue. And they'll kind of gauge sentiment. They'll talk to clients, they'll talk to each other, and they say, oh you know what the demand is. And they'll essentially come up with some price, which is essentially as a high a price as-- they want do a high price because obviously as a company, I want to sell the stock for as much as possible. But they don't want to do it so high that the stock doesn't trade up. Most banks, you want your IPO to look like this. This is the first day of trading, this is your IPO price. They want it to look like that, so that in the future when there's an IPO, people get excited to get in it. If this IPO-- if the stock just did this, if it started collapsing, one, people will lose interest in IPOs in general. And then people will get suspicious about this company. And I'll do a whole video on that. So, how do the mechanics work? Well, they'll say, hey, you want to raise the $50 million, well you could do it a couple ways. We say hey, we're willing to issue another-- let me think of the best way to explain-- we're willing to issue another ten million shares, right? And I'm not drawing it proportionally. Let's say we're willing to issue another ten million shares, and this should be a lot higher, because this is four million right here. We're willing to issue a another ten million shares, how much money can we get for it? And let's see, these bankers talking to essentially the market, and talking to each other. They say hey, we think we can justify these guys, and we're going to do it for a little bit lower than they're actually worth. But we think the market will buy the fact that these guys are worth, I don't know, let's say they're worth $80 million in their current incarnation, right? Which essentially says, before we raise the money, we have $80 million, we have four million shares. So they're saying $20 a share. So if we go and issue another ten million shares at $20 a share, we'll actually raise $200 million. Actually, for the sake of-- so I don't have to edit my math-- let's say that's how much we wanted to raise, $200 million. So essentially what these guys will do, our board of directors will issue these new shares. And then this syndicate of banks, led by the lead underwriter will then sell it to their brokerage clients. To mainly institutional investors, but it might be some favored rich guys. If it's not that favored of an IPO, maybe you might get a call as well. And they'll sell it to all of them. And you say, why are they doing that? Why are they doing all of this work for the company, helping them raise $200 million? And they're going to the pain of the legal work, and they had to put a team of maybe ten guys on this. And they had to make models, and it probably took them maybe two or three months to do it. That's a lot of work, what do they get in exchange for all of this? Well they actually get a commission. And that commission, at least historically, has been 7% of the offering. 7% of the offering. And now you get a sense of why, in a good market, when you can do these things, why it has, in history, paid to be an investment banker. Because 7% of $200 million-- and frankly it's not a lot more work to do a $200 million offering than it is to do a $20 million offering, it's probably about the same amount. But 7% of $200 million is $14 million. So actually these guys aren't going to see $200 million. They're going to see 200 minus 14 million. So they're going to see $186 million. And then these bankers are going to split $14 million. And that probably is about two months of work for maybe ten guys. So you can imagine-- and of course they have the whole bank that has the support, and they have all these-- not anyone could do this. You have to have what they call retail distribution. You have to have kind of a channel that you can plug these shares into to actually get rid of the ten million shares. You see, it's a fairly profitable business. So that's what an initial public offering is. For the first time, a company is selling shares to the public, that is not just to these private investors. And usually on an initial public offering, although it's not always the case, these guys aren't selling their shares as much as they would like to. They're usually locked in for a certain period, just because it looks bad if, especially the insiders-- those were the founders of the company-- actually sell their shares. But six months later, then I can go and sell my shares. Maybe if I do it on a small amount, I can go and sell it in the NASDAQ. And I have a publicly traded price, so on any given day, I know exactly what my shares are worth. And this is an important thing to realize. Because a lot of times when people buy a stock they're like, oh, I've invested in that company. Well, kind of. When you normally buy a stock on an exchange, as the New York Stock Exchange, you're just buying the stock from somebody else. You're not buying the stock from that company. So when you pay $100 for an IBM stock-- I've run out of space, that's why I'm just talking and not drawing, let me erase this. I've run out of time, too. But I think this is an important point. When you buy stock from someone else-- so if I give my $100 and I get a stock certificate of IBM, most of the time, if I were to do this today, I'm just-- this is me, with a mustache-- I'm just getting it from some other dude, right? Well maybe he's happy because he got $100. He's got a top-hat. And this is what happens in the stock market every day. So when I buy that, I'm not really investing in IBM. I'm just buying the money-- I'm just buying that share from another guy. We're just exchanging shares. In an IPO, if I'm one of the IPO investors-- this is me-- my $100 in this situation-- let's see we're dealing with socks.com. Maybe that's it's ticker symbol, SOCK. This time it's actually going to the company. It's actually going to the-- or the website, in this case. Of course 7% is being re-directed to the investment bankers. So when you buying from and IPO you really are, to some degree, making an investment. Just like if you were doing a venture capital. You really are making an investment in a company. Your money will then be used by the company to hire people and build factories and make out a website and do marketing. In this case, you're essentially just trading shares in a secondary market. Secondary market just means that it's not going to the actual company. It's just going to another shareholder who bought it before you. Anyway, I've really gone over my time limit. So I'll see you in the next video.