Sales of shares by the fund to the public in a portfolio company’s initial public offer- ing or through subsequent registered offerings is a fundamental liquidity strategy. When analyzing this strategy, a fund should consider how the following factors would affect its ability to achieve liquidity:
•An IPO is primarily a capital-raising event—current investors may be limited in the amount they can sell in the IPO.
•Market demand for secondary offerings will affect the amount and timing of sales by the fund. If the public market float and trading volume are small, the fund may not be able to sell sizable blocks of its shares to the public.
•While the public market may value the shares at a higher multiple, the market price may deteriorate over time and sales by officers, directors and other signifi- cant stockholders could further depress the trading price.
•Registration rights agreements almost always contain restrictions on forcing the company to register shares, including provisions allowing the underwriters and company to cut back the amount of shares sold by an investor in an offering.
•Significant investors are typically locked up, or restricted from selling shares, for 180 days following an IPO and may be locked up for various periods after later public offerings.
Funds can take a number of steps to assess whether an IPO of a portfolio company will achieve satisfactory liquidity for its equity in the company through secondary offer- ings. First, a fund should evaluate the company’s business prospects and ability to deliver operating results after the IPO that will maintain or increase public stockholder value. This would include consideration of how the company will report results under SEC guidelines and which results public investors and analysts would find important. Second, a fund should analyze its rights under the portfolio company’s organizational agreements and any registration rights and other agreements relating to the fund’s rights to participate in public offerings. Third, the fund should talk with investment banks specializing in the company’s particular industry about the probable strength and depth of the market for secondary of- ferings after the IPO. The market for secondary offerings will depend, in part, on the size of the company and offering; the level of public interest in the company; the strength of the company’s industry or sector; the company’s growth plan and strategies; and the outlook for the stock market generally. All of these matters can affect whether the fund may be able to liquidate its position quickly through a small number of large sales or more slowly through a large number of small sales.
