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Tickers in this Article: ELMD, RP, PCLN, GBL, GMAN
The IPO market is looking a lot like the traffic in Los Angeles. Backlogged. For every nine priced in 2010, another 29 are filed and waiting to go. A major cause of this is private equity firms looking to exit investments. Investors aren't playing nice, wanting a little something extra to let them off the hook. As a result, when issues do make it the starting line, they're pricing below the expected range. Don't feel sorry for them - private equity firms are making out like bandits. It used to be IPOs were for raising working capital for growth businesses. No longer. Now it's simply another payday for individuals who are already wealthy. IPO should really stand for "I'm Pulling Out."

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Recent Pricings
In the month of August, there have been 14 IPOs making it to the starting line becoming public companies. The backlog in IPOs is probably good for private equity firms because the last thing it needs right now is capital, currently sitting on $470 billion in dry powder with seemingly nowhere to put it. It used to be that almost half of private equity exits came by selling to another private equity firm. As of the second quarter, it's down to 28%. Private equity firms make the big money when they realize investments. Unfortunately, for them, deals don't appear to be happening nearly fast enough.

Three Keys to a Good IPO
Investors should look for three things in an IPO. The most important is that the entire proceeds go to the company. IPOs shouldn't be a payday, but rather a growth accelerator. A rare example of this came on August 13 when Minnesota-based Electromed (Nasdaq:ELMD) sold 1.7 million shares for $4 each with all of the proceeds going towards working capital, including adding employees necessary for growth, further research and development and other capital expenditures. Secondly, not one penny went to existing shareholders. In fact, officers and directors have agreed to a one-year lock-up and all others, six months. It's rare, but important. Lastly, on-demand software company RealPage (Nasdaq:RP) recently went public with over half the funds raised going into the pockets of selling shareholders, who made 485% on their investment. With a lock-up period of 180 days and its shares up 58.5% since August 11, 2010, it's almost certain they'll make even more than that come November. The dilutive effect to new investors is 100%. Why play this game?

Bring Back 1999
You can say what you want about the tech bubble, but in those days, IPOs actually raised capital. In March, 1999, both Priceline.com (Nasdaq:PCLN) and GAMCO Investors (NYSE:GBL) went public. The former was a travel startup losing money while the latter was Mario Gabelli's profitable ever-expanding empire. Both offerings could have accommodated a few million additional shares to reward existing shareholders. But that wasn't the way things were done. You went to market to raise funds to grow your business.

Sure, a by-product of this was that founding shareholders got an exit, but it wasn't the main reason for doing so. This has clearly changed. Gordman's (Nasdaq:GMAN), an Omaha-based retailer, went public in August at $11 a share. Less than two years earlier, Sun Capital Partners paid $55.7 million for Gordman's, with just $20 million of its own capital. At the time, Gordman's was profitable. Today, its gross margins are approximately 5% higher. For this improvement, Sun Capital realized $21.9 million from the IPO and sits on another $136.4 million in stock with a lock-up that ends in November. That's a 692% return, or thereabouts, for two years of work. Investors better hope these higher margins stick around.

The Bottom Line
Sun Capital could have raised $30 million from the IPO (the net proceeds going to company) instead of $59 million by not selling any of its own shares. It still would have made a boatload of money come November. I don't begrudge them for doing it; I just wonder what happened to the value-added IPO. (To learn more, see IPO Basics: Introduction.)

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