No-Go IPOs

Why is the IPO market so important? Because, in a cycle central to our economic system, it brings new companies to the fore as old companies decay. To wit, Control Data Corporation and Cray Research, Inc., formerly titans of the local corporate scene, have faded away. They’ve been replaced by companies like Capella Education Company (Nasdaq: CPLA) and Compellent Technologies (NYSE: Arca: CML). Public since November 2006, Minneapolis-based Capella runs an online education company. Compellent of Eden Prairie completed its IPO in October 2007 and is making a splash in the high-tech markets with its data storage systems. (Full disclosure: I’ve served on the board of Compellent as an independent director since April 2007.)

The IPO market also feeds a whole table of service providers. Consider the IPO of Capella. According to the registration statement filed with the Securities and Exchange Commission, Capella paid IPO-related legal fees of about $1.4 million to Minneapolis firm Faegre & Benson, while its accountant, Ernst & Young, earned $655,000 for its IPO work. As one partner at a big downtown law firm told me, the partners who focus on traditional corporate work have little to do these days. Other members of the IPO ecosystem hurt by the lack of activity include financial printers and investor-relations consultants.

Show of Strength

Beyond the coming-out party, often viewed as a form of corporate branding, going public has two primary financial virtues. First, it allows an emerging company to get off the treadmill of private financing, whether venture capital or some variation on the bootstrapping theme. Second, after an IPO, a company has a ready answer to the question: Are you going to be around? In an environment that prizes liquidity above all else, a strong balance sheet with lots of cash quickly puts to bed what can be a pesky question from prospective customers, particularly for technology companies.

If a company can’t go public the traditional way, with underwriters and a marketing blitz (usually sponsored by an investment bank that promotes and positions the company), there is an alternative. Known in the trade as a backdoor IPO or a reverse merger, such a transaction requires two players. One must be a public company that has cash and a stock symbol, but little else. As a so-called “shell,” such a company typically has had a promising operating business that has failed. The second player is an emerging company that has a good “story,” but needs cash.

In early November, Cardiovascular Systems, Inc., a St. Paul–based medical device company, announced such a deal. It plans to merge with Colorado-based Replidyne, Inc. (Nasdaq: RDYN), a shell company that brings about $40 million to the corporate marriage. (Replidyne raised money from a variety of sources before suspending work on its biopharmaceutical products.) In a statement at the time, Cardiovascular Systems CEO David Martin said the transaction was “an expedient way to take our company into the public market and generate a capital infusion for future growth.”