Added On: Wednesday, November 14, 2007

Equity market

It wasn't long ago that companies would go public only after hitting several key benchmarks--things like sales volume, balance sheet strength and (dare we say) profitability. Then came the dot-com boom, when protozoa-like companies were extracting huge sums from wild-eyed investors, followed by a spectacular bust that supposedly imparted some very hard lessons about risk and reward.

Sadly, it seems those lessons have not been completely learned. And that could spell trouble for plenty of entrepreneurs thirsty for their big "liquidity event."

Here's why. First, a mistimed IPO can quickly wipe out what little equity you didn't unload in the public offering. If your company goes out too early and misses performance targets even for one or two quarters, the stock could tank. Worse, just as your company may have been overvalued at the time of the IPO, it might be punished unjustly six months later.

Second, understand that going public does not always equate to a liquidity event for you, the entrepreneur. Usually there is a "lock-up" period between three to six months during which you cannot sell your shares. If the value of your company plummets in the meantime, you've just kissed away substantial wealth.

While it's true that companies going public today are overall in better shape than during the tech bubble, a recent spate are in much weaker shape than they were, say, 20 years ago when there were some generally accepted guidelines for getting investors' attention.

A big one: Companies needed to show roughly four years of profitability before they sold shares to the public. And that makes sense, given that the intrinsic worth of any company is determined by calculating the present value of its future cash flows. Past performance, while by no means a perfect indicator, is at least something to work with.

Not so today. One disconcerting statistic, care of Renaissance Capital's IPOhome.com: 31% of companies that went public between 2003 and 2006 were unprofitable at the time of their offerings. And of the 30 companies that have gone public thus far in 2007, just nine were making money.

I'm not talking about companies underwritten by chop-shop investment banks. Compensation consultancy Salary.com went public in February, with the help of Thomas Weisel Partners and Wachovia Securities--a unit of Wachovia (nyse: WB - news - people )--after three years and nine months of widening losses. Opnext--a former subsidiary of Hitachi (nyse: HIT - news - people ) that makes components for telecom equipment companies such as Cisco Systems (nasdaq: CSCO - news - people ) and Alcatel-Lucent (nyse: ALU - news - people )--bled ink for the same period before going public in February. Opnext's underwriters: Goldman Sachs (nyse: GS - news - people ), JPMorgan Chase (nyse: JPM - news - people ), CIBC World Markets and Jeffries and Co.

Then there's Clearwire, provider of fast, wireless Internet connection. The company sold shares a few days ago with the help of Morgan Stanley (nyse: MS - news - people ), Merrill Lynch (nyse: MER - news - people ) and Bear Sterns (nyse: BSC - news - people ). By the end of 2005, Clearwire had racked up cumulative losses of $174 million. What's more, its filing with the U.S. Securities and Exchange Commission admits that "we expect to continue to realize significant net losses for the foreseeable future."

Sure, some of these bets will pay off, both for entrepreneurs and investors. But little wonder, perhaps, that nearly 40% of companies that went public in 2005 were still unprofitable a year after their offerings--and in a robust economy no less.

Even if you think you are healthy enough (by historical standards) to go public, think long and hard about it. The costs are increasingly prohibitive (for more on this, check out "Are You Ready To Go Public?"). Also ask yourself if you are willing to give up all that equity.

After all, not all liquidity events are created equal.

Brian Hamilton is the chief executive and co-founder of Sageworks, the developer of ProfitCents, a software application that enhances financial analysis and communication for financial professionals.

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