New Horizon Kids Quest, a Plymouth (Minn.) operator of children's entertainment centers at casinos, had pizzazz when it went public back in 1995. Its centers were linked to the hot casino market and had potential to break into other fields. The stock came out at $5 and, in 1996, shot up to $12.25.

Partly to keep control, the company sold only $5 million in shares -- half of what institutional investors consider the minimum for a company's shares to be liquid and their price representative of company value. When the gaming industry slowed, the stock fizzled. New Horizon Kids Quest has been around $2.50 recently. Now its founders have regrets. "I think we were pretty naïve and didn't realize that without institutional investment, the stock has a harder time creeping to where it needs to be and be stable," says Sue Dunkley, president.

New Horizon Kids made a classic mistake of entrepreneurs who take their businesses public. The reflex to keep as much of the company as you can may be appropriate for a closely held concern. But in the public arena, you have a commitment to make your company a good investment for anyone -- not just people who are personally devoted to it. And that requires offering enough shares to create a genuine market.

MobiNetix, a Sunnyvale (Calif.) maker of touch-screen terminals for customer transactions, also has a small float, stemming from its 1996 reverse acquisition, an often-criticized strategy in which a private company merges with a public shell. Company officials thought this would cost less than an IPO and help MobiNetix' simultaneous drive to raise private, preferred equity, because private investors would be able to convert their stakes into tradeable common stock. The company raised $6 million in preferred equity. It then needed to register the preferred shares with the U.S. Securities & Exchange Commission, so that they could be converted to common stock under the new company structure. Registration, which is automatic in an IPO, required an audit of the company's results for the previous three years at a cost of some $500,000. But MobiNetix did not receive the proceeds of the private equity sale from investors in time to complete the registration.

As a result, the company had a float of only 200,000 shares (from both old and new shareholders), no analyst coverage, and wasn't able to graduate to a Nasdaq listing. The company trades on the OTC Bulletin Board, as did the shell company. Consequently, it still doesn't have real access to public capital. "OTC Bulletin Board is not conducive to doing additional public offerings," says Jeffrey Krauss, general partner at Nazem & Co. in New York, a venture-capital firm and one of MobiNetix' preferred shareholders. "So they have not had the ease of access to capital in the way that other growth companies have."

Since 1996, MobiNetix has raised an additional $7 million through private placements. But raising private money involves extensive research and face-to-face negotiations every time. And now, the company has the baggage of being public. "If we had a bigger float [with some conversions of private stock, it's grown to about 550,000 shares], at least we could raise money at a better price and a fairer valuation," CEO Aziz Valliani says. MobiNetix has been relatively lucky. It has successfully raised funds from preferred investors, who -- so far -- haven't insisted that the company spend precious resources on registering their shares.

IPO WOES. Going public too soon sets up expectations that many young companies can't meet. They try to grow too fast and risk failing in the attempt -- putting a viable business in crisis. When Christopher Ljungkull's Legal Research Center in Minneapolis sought $700,000 in financing in 1995, an investment banker offered to take it public with a larger offering. The research service, which had $1.2 million in revenue in 1994, expanded its strategic plan and raised nearly $5 million. But it wasn't enough to finance a costly new Internet-related operation, which was shut down last year. The stock price withered to around 30 cents a share earlier this year as the company restructured. Ljungkull concedes: "We should have started with a smaller private offering, then gone public."

So what's a small company with IPO regrets to do? Some may go private again, buying the shares back. Most entrepreneurs interviewed believe that over time, if they build the business and then develop investor relations, the stock will follow. "The key is you have to stay focused on the business, and hopefully the stock will respond. This is not the end of the story for us," says Robert Soloff, CEO of Sonics & Materials in Newtown, Conn., which recently turned a profit in its fiscal first quarter after a fourth-quarter loss. (See the previous stories in this series.)

But the experience of Jeremy Barbera, CEO of Marketing Services Group in New York, suggests the wait may be long. He more than tripled the company's revenue, to $80 million, in 1996 with three acquisitions. He even got GE Capital to invest. But with the stock at $2.50, investment bank analysts won't track it, the key to luring new institutional investors. "It's a horrible Catch-22," says Barbera. "It's like getting your first credit card. But we'll get past it because of these acquisitions we're doing."

Sure, there are some benefits of being public even without a soaring price -- more financing alternatives, the discipline of disclosure, and the cachet. The problem is that you can't fully reap those benefits if you can't satisfy your company's new co-owners -- the public. "Doing the reverse merger was not the best thing for the company, because it didn't give the shareholders the liquidity they wanted," concedes the CFO David Licurse of MobiNetix. The company is weighing alternatives: to register its private equity to convert it to common shares, to try a secondary offering despite the low valuation, or to go private with the intent of going public via an IPO. Those are tough choices.

Like many small companies, MobiNetix has discovered the hard way that the market is a cruel master -- and it gives its lessons in public.

By Hilary Rosenberg in New York

To: FINANCE