Canceling an initial public offering at the last minute, terminating a years-long process and killing insiders’ financial dreams, is incredibly painful.
When LegalZoom withdrew its IPO the day before its scheduled climax on August 3, the immediate waste of $3.5 million in cash was probably bearable. The likely damage to the firm’s reputation and relationships within financial circles, not so much.
The company blamed its decision on the old standby, “market conditions,” an euphemism for “things didn’t come together the way we expected and the time came to run like hell.” The real story concerns how the firm and its presumably professional financial advisors allowed the process to go so far along without pulling the pin much earlier. In this case, the fat lady’s final song was not so much a duet between LegalZoom and its underwriters but rather a trio performance that included them as well as LZ’s major institutional investor and largest selling shareholder, Polaris Venture Partners V.
PVP V, an icon of institutional venture capital, was formed in March 2006 with nearly $1 billion of cash and promised investments. In February 2007, it poured more than $35 million of its investors’ funds into the purchase of about 80% of LZ’s Series A preferred shares at a price just under $6.00 per share.
Roll the calendar forward to 2012. PVP V is facing, in VC years, middle-age. It has just four years left to wind up its investments and return its investors’ money and, presumably, their gains. It’s time for PVP V to turn its vault full of paper shares into real cash; time for its investments to undergo a “liquidation event” such as a sale or an IPO.
Thirty-six hours before the stock was to start trading, the underwriters called a “reality meeting.” The IPO could not happen on numbers the conflicted parties were demanding. On August 3, of the 8 million shares scheduled to be sold by LegalZoom’s underwriters, less than half were for the company. Strike one. Of the fifty-two percent to be sold by insiders, almost 90% were to be from PVP V, looking to get essentially all of its invested cash out. Strike two. Investors’ weren’t sufficiently hungry for the stock to support the price that the sellers were demanding. Strike three.
Partly, it was the numbers themselves. LegalZoom was already experiencing the chill of a slowing growth rate and tighter margins in its traditional market, legal forms for sale. In attempts to compensate, the firm boosted its consumer advertising by more than 40%. During the IPO it was aggressively rolling out a new subscription pricing model where consumers commit to a fixed monthly fee in return for legal forms and limited consultations with affiliated attorneys. Also, LZ began to compete in the registered agent market for small companies against the established players, such as CT Corporation. Investors don’t like it when their investments go to someone other than the company in which they are investing. They don’t like it when a company’s most sophisticated investor is taking big money out, leaving only “house money” still at risk. And after Facebook, they really don’t like any negative factors mixing with rich pricing.
LegalZoom’s agreement with its PVP V and its other Series A investors called for them to convert their preferred shares into common stock coincidentally with an IPO that would raise at least $50 million for the company with shares priced at $9.00 or more.
It tried. It failed.
Now, under those same agreements, it’s faced with a mandatory redemption to pay off the Series A investors for $71 million in less than 18 months. Or lose control of the company.
Even roses have thorns.
UPDATE: There’s an interesting and different perspective at eLawyering Blog.
UPDATE and BUMPED: LegalZoom nearly ran out its clock, but this deal as very well-described by Michael Carney may save the insiders hides and provide them a way to earn out a much smaller fortune than they had wished.