A Different Kind of IPO

Wall Street insiders and much of the financial press could not stop humming Google'

Wall Street insiders and much of the financial press could not stop humming Google’s requiem in the final days prior to the company’s lurch into the publicly traded stock market this past August.

"The Google golden boys who could do no wrong as they built an Internet search-engine powerhouse have gotten a harsh lesson in the dangers of Hubris.com," crowed USA Today on the eve of Google’s IPO (initial public offering).

Self-fulfilling prophecies aren’t always self-fulfilling on the Street, however. Following the IPO, Google co-founders Sergey Brin and Larry Page are multibillionaires (at least on paper). And the technology company raised a mountain of cash that it will use to take on Yahoo! and other online competitors.

So why did all the dark clouds hover over Google as it was poised to become one of the most highly valued companies in the world?

Google’s management and founders had the audacity, yes the hubris, to run its IPO in a democratic way that would spread the wealth beyond the biggest fish in banking. They made a remarkable decision to circumvent the standard IPO process and go directly to the small investor, thereby denying the investment banking sector the sole right to underwrite its shares.

IN A TYPICAL IPO process, a company hires investment bankers to sell its shares to professional money managers (broadly known as "institutional investors"). The institutional investors get the shares at a comparably low price, the value of which pops upward once the shares hit the open market. Investment bankers also pass along the low-priced shares to individual investors whose favor they hope to curry, particularly executives of companies whose business they would like to have in the future.

I will never forget the day my eyes were opened to how unfairly the capital markets were rigged for the benefit of insiders. In 1999, I was searching for capital funding for a start-up company. A friend introduced me to a banker at Smith Barney (at the time it was Solomon Smith Barney), an investment bank that was wildly successful during the telecom boom. The banker managed the personal wealth assets of some of the star CEOs of technology enterprises. No doubt to impress me with the leverage that his bank could bring my company, he reviewed some of the recent IPOs that it had led. He gloated about the shares that his firm had allocated at prices ridiculously low given the heights to which the stock later soared.

Two years later I saw this banker’s name in the paper; he was charged with handing out stocks to a select group of top executives (whose companies he hoped to retain for lucrative acquisition transactions) at IPO prices even after the stock was trading on the open market. It would be hard to find a lower risk model for investing.

It was exactly this kind of cronyism that Google aimed to challenge. It deployed an unusual "Dutch auction" method that gave small-fry investors access to IPO shares and limited the fees that went to bankers. Potential buyers could bid for as few as five shares—a tiny allotment unheard of in the typical IPO process. The bidding also was intended to set a fair share price so that the price would not be artificially deflated on the first day of public trading.

Partly for that reason, Google shares did not emerge from its IPO as high as its own projections forecast. Nor did its share price pop wildly the first day of trading. No doubt "I told you so" was the most commonly heard phrase in central Manhattan.

But only Mark Twain could appreciate fully the premature celebration of a demise foretold. Google’s IPO was far from perfect—which could be expected, given the untested path it sought to tread—but it was a huge success in its own terms. In a marked departure from other IPOs, small investors and hedge funds drove significant traffic the first week of the trading; the majority of orders were for lots of 300 shares or less.

Google itself also did exceedingly well, in part because the auction method brought more capital back to the company than would have been realized had an investment banker underwritten the process. As of Sept. 1, its market capitalization value was more than $27 billion.

So the only real losers turn out to be the Wall Street money managers. I hope they aren’t offended that their whining does not bring us to tears.

David Batstone is executive editor of Sojourners magazine and author of Saving the Corporate Soul.

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