Question

S&S AIR GOES PUBLIC

Mark Sexton and Todd Story have been discussing the future of S&S Air. The company has been experiencing fast growth, and the two see only clear skies in the company’s future. However, the fast growth can no longer be funded by internal sources, so Mark and Todd have decided the time is right to take the company public. To this end, they have entered into discussions with the investment bank of Crowe & Mallard. The company has a working relationship with Renata Harper, the underwriter who assisted with the company’s previous bond offering. Crowe & Mallard have assisted numerous small companies in the IPO process, so Mark and Todd feel confident with this choice.

Renata begins by telling Mark and Todd about the process. Although Crowe & Mallard charged an underwriter fee of 4 percent on the bond offering, the underwriter fee is 7 percent on all initial stock offerings of the size of S&S Air’s offering. Renata tells Mark and Todd that the company can expect to pay about $2.1 million in legal fees and expenses, $12,000 in SEC registration fees, and $15,000 in other filing fees. Additionally, to be listed on the NASDAQ, the company must pay $100,000. There are also transfer agent fees of $6,500 and engraving expenses of $520,000. The company should also expect to pay $110,000 for other expenses associated with the IPO.

Finally, Renata tells Mark and Todd that to file with the SEC, the company must provide three years’ audited financial statements. She is unsure about the costs of the audit. Mark tells Renata that the company provides audited financial statements as part of the bond covenant, and the company pays $300,000 per year for the outside auditor.

Questions

1. During the discussion of the potential IPO and S&S Air’s future, Mark states that he feels the company should raise $85 million. However, Renata points out that if the company needs more cash in the near future, a secondary offering close to the IPO would be problematic. Instead, she suggests that the company should raise $95 million in the IPO. How can we calculate the optimal size of the IPO? What are the advantages and disadvantages of increasing the size of the IPO to $95 million?

2. After deliberation, Mark and Todd have decided that the company should use a firm commitment offering with Crowe & Mallard as the lead underwriter. The IPO will be for $85 million. Ignoring underpricing, how much will the IPO cost the company as a percentage of the funds received?

3. Many employees of S&S Air have shares of stock in the company because of an existing employee stock purchase plan. To sell the stock, the employees can tender their shares to be sold in the IPO at the offering price, or the employees can retain their stock and sell it in the secondary market after S&S Air goes public. Todd asks you to advise the employees about which option is best. What would you suggest to the employees?

Answer 1

S & S Air
Q.No.	Answer
1)	To calculate optimal IPO size, the following factors shall be looked into - a. The expectation of subscription, if the required number of subscriptions is not received, the company will not be able to list its shares on the stock exchange. If the company is confident of receiving subscriptions based on fundamentals of the company it must increase IPO size. b. Increasing the IPO size means increased underwriting cost, which shall not be the case in case of FPO. This supports that IPO size shall be reduced. c. When IPO is oversubscribed and shares are sold at a premium, all the premium amount is received by the company and the amount received in excess of par value is not pocketed by investors. Keeping in mind all these qualitative factors and financial factors optimal size shall be decided.
2)	Calculation of cost of funds received:
Sr.No.	Particulars	Amount (Mn $)
A)	Total costs involved in IPO:
1	Underwriting fees @ 4% (85*4% = 3.40 million)	3.4000
2	Legal Fees and Expenses	2.1000
3	SEC registration charges (12000/1000000)	0.0120
4	Other Filing Fees	0.0150
5	NASDAQ Fees	0.1000
6	Transfer Agent Fees	0.0065
7	Engraving Expenses	0.5200
8	Other Expenses	0.1100
9	Audit Fees (Since this is not the cost specifically incurred for IPO)	0.0000
10	Total	6.2635
B)	Funds Raised using IPO	85.0000
C)	Cost of funds as a percentage of IPO proceeds (A/B)	7.37%
3)	Advice to the employees As the company expects oversubscription, employees must not offer their shares in the IPO, let the shares be listed first and then sell them in the secondary market, as the market price will go up after listing, so employees can get more benefit from selling in the secondary market.