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One Way Investment Banks looted their customer: The IPO Process

I am just capturing my comment at TDAXP:

One area in which Investment Bankers did great harm to the US Economy was in the area of handling IPOs.

Investment Bankers essentially used the process as a means of looting wealth from the entrepreneurial firms going public for the benefit of the investment bank and some its choice customers to the detriment of the Entrepreneurial Company and its founder/owners.

While I don’t know if the process started out that way, by the time of the internet boom in the mid 1990’s it was.

Here is how the looting worked.

ACME Systems is a growing Network Service Provider. The founder and the VCs decide to take the company public in order to raise cash for growth for company, to reward the founders and reward/payback the early investors and VCs.

ACME Systems hires investment bank Natas, Laab & Ikol (NLI) to help with this. ACME will pay NLI to 1) Value the company and 2) Manage the Public Offering.

NLI will get a shitload of money for this.

Preparing for the IPO, NLI determines that the ACME public offering will be 10 million shares at $20/share valuing ACME at $200 million. The source of the shares will be from the founders (some of their shares), the early investors (some of their shares),  but mostly the shares will be new shares with purpose of raising money for the company to further grow (and become profitable or more profitable.

So, IPO day occurs and lo and behold the stock price jumps up to $27/share. The business journalist and shareholder are giddy at the day one bump. By the end of the week the price is $32/share. The company is now valued at $320 million and market value increase of $120million.

This IPO day scenario happened again and again.

So, everybody was happy right? It is a good thing that the stock price jumped up so high on day one,right?

The answer is no. The founders, initial investors and the company just got looted NLI.

Besides the large pile of cash paid to NLI for their “expertise” in handling IPO, they also bought shares at that opening price and let choice customers of theirs (favorite insiders) all by shares at that opening price.

Rarely did the stock price drop after IPO day. It almost always rose. This suggests that through malice, NLI purposefully recommended an IPO price/share that undervalued the company. The $120million rise in market price – that wealth should have gone to the founders, early investors, and the cash accounts of ACME. The $120 million that should be in ACME bank accounts for growth and job creation has instead mostly ended up in the bank accounts of NLI and its favored customers.

NLI did nothing to “earn” this extra wealth. Remember, they were paid big time to manage the IPO and value the company. This extra wealth is money they looted by manipulating the process. How many companies with good ideas and products would have survived if they had more of the they should have had in order to get their product or service offering up and running? How many jobs would that have been? How much has lost by these companies not surviving because NLI pilfered from them?

I am glad NLI and real-world banks like them are going or gone. Fuck them. They are not needed anymore. Maybe in the old days, there was no other way to do IPOs. That is no longer true.

The right way to do IPOs is through an Open Auction [1] after a set time period by which firms and individuals can use their individuals skills to determine an appropriate share price. Using this Wisdom-of-the-Crowds approach a good share price can be derived and the IPO can do what it is meant to do: raise cash for the company by selling a percentage of the company at a fair price.

[1] http://www.wrhambrecht.com/ind/auctions/openipo/index.html

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