Going Public: Researching Options Is Crucial for Device Companies

Medical Device & Diagnostic Industry Magazine
MDDI Article Index

An MD&DI April 1997 Column

BOTTOM LINE

Device companies considering when and how to make an initial public offering need to examine all the options before taking the plunge.

Initial public offerings (IPOs) have been an especially hot topic in technology fields during the past two years, with medical technology in particular generating a lot of the heat. For up-and-coming medical technology companies, going public can make the difference between raising the capital that is essential for research and development and failing to bring a possibly life-saving concept to fruition.

The main problem with taking medical technology companies public is that many do so on the strength of a great idea or a proprietary technology, but without having the financial depth, market knowledge, management skills, or even FDA approval necessary to develop, make, and market the product properly. For such idea-driven companies, the decision to go public needs to be made only after research and scrutiny; the wrong decision can lead to corporate catastrophe. One road to potential disaster is naively trusting promoters--underwriters and others who make their money from taking a cut of the first monies raised from the IPO--people who have dollar signs in their eyes but don't have a vested interest in the company's long-term success. The stock market is rife with stories of companies that went public at $1 per share, only to plummet to $0.20 or $0.30 when the underwriter wasn't committed to the company or its long-term support. To get listed on NASDAQ (National Association of Securities Dealers Automatic Quotation), a company needs to go public at $5 (or more) per share. NASD's bulletin board lists stocks that do not warrant daily electronic quotation based on their price, trading volume, and company capitalization. Bulletin board stocks often languish. Thus, a company must decide whether to go out as a so-called dollar stock or wait and go for interim private funding and an eventual NASDAQ listing. Because lower-priced stocks can be easily manipulated, they are considered risky.

Some companies that successfully go public subsequently mismanage their newfound riches to the point where the stock price never reaches its potential. Such mismanagement is often the result of executives failing to adequately research the general financial environment and that of the medical device industry in particular. Learning what is required to fiscally manage a medical technology firm under the intense glow of the public spotlight cannot be overlooked.

Going public and keeping the price and volume of a medical technology company's stock consistently rising requires extensive education and understanding on the part of the company's management. This article discusses some of the key factors that are involved in making the decision whether or not to go public, how to guarantee success after an IPO, and what unique problems a medical technology company faces en route to fame and fortune on Wall Street.

MORE THAN JUST AN IDEA?

Many medical technology companies start with a great concept, then immediately try to go public before there is anything to actually show or any assurance that the concept will ever become real. Going public with only an idea or concept is often seen as risky by Wall Street, and leaves a company more susceptible to dealing with promoters from a position of weakness, making bad deals in the short term in order to facilitate the IPO. In these cases, for example, the brokerage firm or underwriter handling the IPO will ask for a higher-than-normal percentage of shares in payment to compensate for the presumably greater financial risk it is taking. Having more shares, however, means that the firm or underwriter could flood the market with them after the IPO is made, driving down the price of the company's stock and increasing the chance for failure.

The more tangible a company's product, then, the greater the chances of success in the IPO process. The company can deal with the financial community from a position of strength because it and its product have more integrity.

A second reality check for a medical company considering an IPO is whether its product has received FDA marketing approval. If it hasn't, is the company absolutely confident that the product will receive such approval, and can it convey this confidence convincingly to Wall Street? For many of the same reasons indicated above, FDA approval, far from being a financial abstraction, can add dollars to the valuation in any IPO. Even more critical, many underwriters won't seriously entertain taking a medical technology firm to prospective investors without FDA approval. At the very least, most reputable underwriters will insist that the company be well along in the FDA process, and certainly in clinical trials for an investigational device exemption (IDE).

ARE CAPITAL RESERVES SUFFICIENT?

Having less than $1 million in capital almost nullifies a company's chances of going public through a traditional Securities and Exchange Commission (SEC) IPO registration, filing, and underwriting process. Companies with capital reserves under $1 million might consider entering the public arena through a merger with an existing but inactive public company, called a shell. A shell is a preformed public entity, usually obtained from a firm that went public but has ceased day-to-day operations. When such a firm stops doing business the official public entity remains, and a company looking to go public can merge with it, retaining its corporate identity without going through the complicated and expensive IPO process. The transaction is known as a reverse merger.

Financial advisers can guide a company toward an available shell. One of the most important considerations when going public through this type of merger is to be sure that the founding company has left no outstanding debts, financial obligations, or hidden liabilities. A firm that goes public by merging with a shell that has outstanding debts or other liabilities will be responsible for them. Thus, a firm that goes public through a reverse merger, in which its identity survives, needs to use qualified attorneys skilled in securities law to examine the transaction thoroughly and determine whether any unpaid taxes, lawsuits, or other type of previous business liability exist.

The issue of competent legal advice needs to be emphasized. Although a medical technology company is likely to already have legal counsel, patent attorneys, and other advisers, securities law is a complex specialty requiring separate legal counsel.

Along the same lines, it is helpful for a medical company going public to retain an intermediary advisory firm or an investment banking firm to help write the new issue registration referred to as an S-1 and negotiate the underwriter and investment banking fees. Such a firm can help focus on the medical company's strategic direction and actually write the memorandum used to get an underwriter to prepare a placement. It can also help with European distribution and setting up strategic alliances if the company lacks sufficient infrastructure to take full marketing advantage of its new technology.

CLUING IN MANAGEMENT

Understanding the ins and outs of Wall Street demands a different body of knowledge than that necessary to develop innovative medical devices. Understanding this difference is particularly important for smaller medical technology companies that decide to go public using either the SEC IPO registration or the public shell merger techniques, since such companies are often headed by persons who know more about science than about finance. In those cases, the most important thing management can do is educate itself in the inner workings of the stock market as well as in the related legal and fiduciary responsibilities of a federally regulated enterprise. This point cannot be overemphasized. Medical technology executives must learn the nuances of the public stock market in order for their companies to succeed. The timing of an IPO, for example, can be important. Company management needs to look at the history of recent IPOs, since their performance will help determine how new ones are valued.

Sources for information on these topics include libraries and bookstores. There are many books that deal with the various rules and workings of the SEC and NASD. The Internet is also a good source of information, with the publicly available address www.hoovers.com linked to all IPOs.

The regulatory and professional organizations themselves are also good sources of information. Companies going public can write to the SEC and NASD for information on rules and regulations governing public companies. Along with securities lawyers who can serve as a valuable resource, every company that is either public or planning to go public should use a certified public accountant. Both public companies and prospective public companies are required to have certified financial statements and an auditor's opinion about their financial condition. The financial markets and government regulators rely on the public accounting firms engaged to independently audit public companies to provide thorough and accurate information. Thus, most major CPA firms have partners who specialize in SEC practice. Such firms usually have literature on the process and can be of great assistance in matters relating to public company activities.

Finally, medical technology executives should consider taking some college courses on the stock market and corporate finance that can help them understand the basics.

EXPANDING THE COMPANY

Once management has learned what it needs to know about the public arena, a strategy for increasing the value of the stock is to expand earnings per share through increased company revenues and profits. One of the most attractive ways to achieve this growth is through mergers and acquisitions. They have become a popular strategy in the business world, and medical technology companies are no exception. Acquiring companies with compatible or competitive products through the use of public stock can turn a medical company into an industry powerhouse by helping it obtain experienced management, a customer base, and shareholders.

Projecting a good public image by engaging in effective public relations may seem a matter of common sense, but often it is not. Many companies in the medical technology field generate a steady stream of advances that could fuel a slew of press releases, but don't take advantage of the opportunity. Public companies have a responsibility to their shareholders, investors, and financial markets to constantly report that they are growing and evolving. New advances, new products, FDA approvals of new products, alliances, executive hires and promotions, and acquisitions all need to be communicated to shareholders and the investor community. Such news reminds them that the company is promising, viable, and performing well. People who see that a company is continually engaging in positive activity are encouraged and more likely to buy stock. Dynamic and consistent public relations show the business world that a company is worth their respect and their investment. Public relations companies can help establish credibility with the financial press.

CONCLUSION

Before leaping into the public arena, a company's management needs to learn all aspects of going public and the on-going responsibilities that it entails. Then management should surround itself with experts in the field.

B. Joseph Vincent is managing director of the Management Group, the strategic planning, consulting, and capital advisory subsidiary of Boca Raton, FL­based Communications Group.

Copyright © 1997 Medical Device & Diagnostic Industry