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Dutch Auctions and Their Fans

There is no better David vs. Goliath story in the financial markets than the battle between the Dutch auction IPO and the traditional IPO.

Pioneered by Bill Hambrecht at his firm, WR Hambrecht, the Dutch auction IPO has investors bid on what they would pay for shares. The price is set when it is low enough such that there are enough participants willing to pay for it so the proceeds will equal the amount the company wanted to raise.

In the more traditional IPO, the investment bank will usually set the price. The bank will set it low enough so that its large institutional customers (who generate the most trading commissions) get a price low enough so they can get a pop out of the gate. In the Internet boom, stocks were often doubling or tripling right at the open, presenting a substantial reward to the customers of the banks but unfortunately raising less money than was potentially available for the companies going public.

"I became uneasy with the traditional IPO process when Hambrecht & Quist went public," Bill Hambrecht says. "The institutions that were long-standing customers of H&Q couldn't get into the IPO. Only the favored customers of the banks could." Hambrecht eventually left H&Q and started up his firm where he brought winery Ravenswood public at $10.50 a share in the first Dutch auction IPO. Ravenswood got bought a year later by Constellation (STZ) for $30 a share, almost triple from its IPO time.

Since that first offering, 11 more companies have gone public through the Dutch auction process, including Google (GOOG). On average, buying a company at its Dutch auction IPO price would've resulted in a 90% return per trade. This is in contrast to the overall market, which has declined since the first Dutch auction IPO in 1999.

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