THE NEW AGE OF Capital Democracy

Chief Executive, The, Nov, 1999 by C.J. Prince

These guys may look like new kids, but they've been around the block more than once. Now they're determined to put the public back in IPO - and they may just eat Wall Street's lunch while they're at it.

Meet company X.com. Two years after its launch, with the IPO market hopping, X.com's founders decided it was high time to go public. They opted to go out with Goldman Sachs, who wooed young X.com with promises of market expertise, analyst coverage, generous aftermarket support, and of course, the Goldman signature - all for the low, low price of the standard 7 percent fee. A few short phone calls were made at the shares - priced at a paltry $11 - were quickly sold to several institutional clients and a short list of valued private investors, none of whom had any personal attachment or affiliation with the company, but who saw dollar signs in the near term. By the time retail investors could lay hands on the stock, it was trading at $65 and they devoured it, sending the price to a whopping $90 by the end of the first day's trading.

The tab wasn't cheap and the money left on the table was almost enough to make X.com's board members weep, but they consoled themselves with thoughts of the indelible imprint they had left on the public eye. The second week out, however, two out of four of the institutional investors decided the stock was already high enough to turn a substantial profit, so they dumped their three million shares apiece, sending the stock plummeting - and it continued to free-fall as individual investors who bought high realized they picked yet another lemon and rushed to unload. The fact that X.com was a solid company with a sound strategy and a growing customer base never factored into the drama. But then, what's that got to do with an IPO anyway?

If that sounds extreme, it's not far off from the way things are. Or, more aptly, the way they were - if the Street's newest Net-based capital players have anything to say about it. Armed with fresh strategies and new models for raising equity, Wit Capital's co-CEOs Robert Lessin and Ronald Readmond, and W.R. Hambrecht's chief Bill Hambrecht are going after Wall Street's lunch. Their battle hymn? It's savvy individual investors, particularly those who believe in a company's mission and its product, who ought to be its primary initial investors - not faceless institutions, many of whom, truth be told, flip stock as shamelessly as the most fickle of daytraders. "[Institutions] essentially use a privileged position to generate a gain that I wouldn't be moralistic enough to say they have no right to, but they really added no value to," says David Schehr, senior research analyst, Gartner Group financial services. "They're simply constricting access and through that, getting an inordinate gain for relatively little risk."

Wit Capital's leaders hope to help break that trend. While Wit doesn't lead manage deals yet, the New York City-based firm, now in its third year - and a long way in Internet time from the day founder Andy Klein first saw the potential value in offering shares of a company's stock to its own best retail customers - co-manages deals with the big boys and reportedly gets as many as 500,000 shares of IPO deals. (Wit has gotten that high-end number mostly from deals led by Goldman Sachs, which owns a 13 percent stake in the firm, and has brought Wit in on 22 of its 69 lead-managed deals since April. Goldman declined to comment on the relationship.)

Wit then offers the stock to its retail customers on a first-come, first-served basis, and they are required to hold the stock for at least 60 days - or risk being booted to the end of the line for future allocations. The company boasts an 80 percent retention rate of stock among investors after the 60 days are up, according to Lessin. Why? "Much of it is targeted toward the community that is particularly relevant to the issuer," he says. "To the extent that you have interested shareholders, they're going to be less likely to flip the stock."

While the Wit model is not entirely new - more evolutionary with regard to distribution of IPO shares than revolutionary, to be sure - it aims to chip away at the share of market held by the Morgans and the Merrills from inside the traditional Street model, by slowly building brand recognition and investment research capabilities and by convincing IPO companies that Wit, as co-manager, can extend their retail distribution and offer expertise they simply can't do without.

San Francisco-based W.R. Hambrecht & Co., for its part, aims to scrap the current tradition altogether and replace it with OpenIPO, a Dutch auction method of IPO allocation. The process is simple: W.R. Hambrecht, as lead manager, offers the stock; potential investors bid (through accounts with either Hambrecht or other participating brokerages) for a specific number of shares and set the price they're willing to pay; the bidding continues until the highest price at which the entire lot of shares can be sold is reached. The result: the IPO company gets arguably the best price for its stock, leaves as little money on the table as possible, while paying a competitive 3 to 5 percent fee to W.R. Hambrecht, and investors can bid as high as they like and they can't overpay. Since the potential for a runaway run-up is slim to none, daytraders and flippers have little incentive to join in; i.e., only loyal investors who believe in the company's mission need apply.