Recent IPOs and the IPO Bump

July 5, 2011 at 4:45 pm Leave a comment

The “IPO Bump” refers to the difference in the exercise price of stock option grants and the offering price at the IPO. The theory is that employees are sometimes granted stock options with strike prices that are at a discount relative to the IPO price (especially in the period immediately preceding the IPO). There has been some speculation on whether 409A rules (among other factors) are leading to the end of the IPO Bump.

IRC 409A requires the company to estimate the fair market value of its stock at the time of an option grant. As a venture capital backed company grows successfully and starts aiming for an IPO exit, the fair market value of the stock should grow as well, in theory. If the company had perfect foresight, the discount relative to the IPO price should decrease the closer the company gets to an IPO.

One comment first: most stock options are subject to vesting limitations over several years (usually four years), so any grants in the period preceding an IPO do not lead necessarily to an immediate windfall at IPO. The employee will only receive the incremental value if the company itself is able to grow in value in the years after the IPO.

Based on several recent IPOs, experience indicates the IPO Bump appears to be alive and well. I looked at SEC filings by LinkedIn, ZipCar, Boingo Wireless, and Freescale Semiconductor, as well as their traded prices as of June 7th:

LinkedIn Corporation operates an online professional network designed to help members find jobs, connect with other professionals, and locate business opportunities. This company’s IPO occurred on May 24, 2011 at a price of $45.00 per share. The price two weeks after the IPO was $77.82. In addition to the increase in value since its debut, holders of stock options granted in the two years preceding the IPO received impressive bumps relative to its issue price: stock options granted two years before the IPO had exercise prices of $2.32 per share (5% of the issue price). Options granted one year before the IPO had exercise prices of $6.20 per share (14% of the issue price). Options granted about 3 to 4 months before the IPO had exercise prices of $9.63 per share (44% of the issue price). [The Brenner Group has provided valuation services for LinkedIn.]

Zipcar, Inc. operates a car sharing network that provides self-service vehicles that are located in reserved parking spaces throughout the neighborhoods where its customers live and work. This company’s IPO occurred on April 19, 2011 at a price of $18.00 per share. The price seven weeks later was $21.54. Holders of stock options granted in the two years preceding the IPO received positive bumps relative to its issue price: stock options granted two years before the IPO had exercise prices of $5.10 per share (28% of the issue price). Options granted one year before the IPO had exercise prices of $8.74 per share (49% of the issue price). Options granted about 3 to 4 months before the IPO had exercise prices of $11.90 per share (66% of the issue price).

Boingo Wireless, Inc. provides mobile Internet access service through wireless fidelity (Wi-Fi) networks. This company’s IPO occurred on May 9, 2011 at a price of $13.50 per share. The price five weeks later had declined to $8.87. Holders of stock options granted in the two years preceding the IPO received positive bumps relative to its issue price: stock options granted two years before the IPO had exercise prices of $1.40 per share (10% of the issue price). Options granted one year before the IPO had exercise prices of $2.85 per share (21% of the issue price). Options granted about 3 to 4 months before the IPO had exercise prices of $8.50 per share (63% of the issue price).

Freescale Semiconductor Inc. provides semiconductors, microprocessors, and similar electronic devices for automotive and telecommunications products. This company’s IPO occurred on June 1 2011 at a price of $18.00 per share. The price one week later was $18.12. Holders of stock options granted in the first quarter of 2011 received a positive bump relative to its issue price: stock options granted three to five months before the IPO had an average exercise prices of $12.69 per share (71% of the issue price).

Stock options continue to be an important element of compensation. However, as demonstrated in the discussion above, not all IPOs result in an IPO bump for all option grants. It should not be assumed that every IPO provides a guaranteed bump in value to the employees that receive options in the period before the IPO. The recent IPOs discussed in this blog would suggest the IPO Bump is still with us, although the magnitude of the benefit can vary significantly from IPO to IPO.

Gunther Hofmann is a Vice President of The Brenner Group and has done extensive work in valuations, M&A, venture capital, and corporate finance with significant international experience in small firms as well as global corporations. Gunther earned a Masters Degree in Electrical Engineering and Business Administration from Darmstadt University of Technology in Germany, and was a Visiting Scholar at UC Berkeley. He is a holder of the Chartered Financial Analyst designation, and a member of the National Association of Certified Valuation Analysts. Gunther is Chairman of the Software/IT Industry Group of the German American Business Association (GABA).

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Entry filed under: Financial Advisory, Interim Management, Valuations.

Where Are All the Tech IPOs in 2011? Part Two. The Latest IPO Bumps

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