Warning Signs for IPOs

An article by Dawn Kamamoto entitled "5 Warning Signs for IPOs" appeared yesterday on The Motley Fool website.  Here's the link:  http://www.fool.com/investing/general/2011/10/14/5-warning-signs-for-ipos.aspx.  In this article, the author lists 5 warning signs that there may be issues for an upcoming IPO:

1. Restatement of revenues in excess of 25%;
2. A new CFO is brought in prior to the IPO;
3. A change in auditors;
4. A change in lead underwriters; and
5. A change in lawyers.

As a former investment banker, these items seem pretty obvious to me, but I applaud the article for reminding people that IPOs are risky and one should pay close attention and really research a company and its prospects before investing in an IPO.  Based upon my experience, I would add a few more items that may signal areas of concern for an IPO:

1. Company-specific accounting metrics.  If a company creates an accounting metric and asks potential investors to focus on that metric, it usually means that standard metrics do not paint the company in the most favorable light.  Rapidly growing companies may generate significant losses as sales and marketing expenses ramp up.  Some company-specific metrics are useful, while others are not.  All in all, one should be wary of company-specific accounting metrics and research the story behind these metrics.
2. High percentage of selling shareholders.  As the time from initial venture investment to IPO has grown longer, it is more common to see existing shareholders sell in an IPO.  Insiders that don't sell in the IPO are usually prohibited from selling shares for a lock-up period of 180 days after the IPO.  However, in my view, it is better to have no selling shareholders in an IPO, which signals to the market that the insiders have faith in the after-market performance of the company's stock.
3. Two classes of shareholdings.  In many companies (such as Google) there exists two classes of common stock:  regular common stock (Class A) held by public investors, and super-voting common stock (Class B) held by insiders.  The purpose of super-voting common stock is to allow insiders (usually founders) to maintain control over a company after it goes public.  While in many cases this can be a good and stabilizing feature, it really depends on the company and the people who will maintain control.

These comments are in addition to the fundamental research one should conduct on a company that is in registration for its IPO.  Nothing can substitute for in-depth research on a company prior to investment.