An initial public offering or IPO is a course of action performed by a company that has decided to take its business from private to public.
Also called as, “going public,” an IPO is the first time an unlisted firm sells new or existing securities, including shares, to the public. It also the first time the owners of the company share their ownership to stockholders.
IPOs are a step-by-step procedure and just do not happen overnight. The IPO process may tend to get complicated and requires great effort to put together. So here are the steps involved in an IPO, which can take from six months to about a year to accomplish.
Hire an Investment Bank
A company planning to go public will need to choose an investment bank or banks to manage the IPO. The firm can sell shares on its own, but that never seemed to happen.
Investment banks offer advice on the company’s IPO as well as underwriting services. Underwriting is the IPO process performed by investment banks. They are selected based on the following criteria:
- Quality of research
- Industry expertise
Investment banks can work alone or as a team on one IPO, with one acting as the leader. Such agreement usually occurs when the lead bank seeks to distribute the funding and risk of the IPO among multiple banks.
The team will examine the firm’s current financial state, work with their assets and liabilities, and then they make a plan to see to the financial needs. They determine regions where cash flow can be raised. Some firms also try to find new management and board members to supervise the new public business.
An underwriting agreement will then be signed, which will cover the details of the deal, including the amount to be raised from the IPO and the type of securities to be issued.
Keep in mind that underwriters can guarantee on the capital they will raise, but they cannot promise anything. Investment banks will not carry all the risks involved during the IPO process.
Form a Registration Statement
After the company and the investment bank have signed the underwriting agreement, the issuing firm and its underwriters together compose a registration statement to be filed with the Securities Exchange Commission (SEC). Registering with the agency usually takes more than a month to complete. The statement is divided into two sections:
This is presented to every investor buying the issued security. It comprises the company’s information, except for the proposed price and date, which have not been made available to the public just yet. Underwriters put together a prospectus after the IPO has been approved.
This contains the details that the SEC will need to assess. These are the information unknown to the public temporarily.
The registration statement must also be able to explain how the company plans to use the funds it will obtain from the IPO and about the securities of public investment.
The SEC will then perform due diligence to ensure all the details provided were correct, and that all financial information have been disclosed properly. Once everything checks out with the agency, the company will be given a green light to schedule the IPO.
Start the Road Show
Going on a road show provides the company a marketing venue to attract prospective investors for the upcoming IPO.
Underwriters travel around the world, or they show a video or internet presentation of facts and figures that may help catch investors’ interest in the IPO. A road show takes about one or two weeks to complete. If a potential investor likes the IPO, he/she can own the shares for the predetermined price specified before the stock listing.
A beginner investor? See also 9 Things to Know to be a Successful Investor to get started on your investing journey.
Investment banks do not just pick the investors at random. They choose based on:
Larger institutional investors, such as pension funds fall under this criterion, making them a more likely participant.
Interest and Background
If the issuing firm has not done any tech investments, for instance, the bank might just skip showing them tech IPOs.
Potential Brokerage Fees
Investment banks might offer certain companies a hot IPO as a favor, to have additional businesses in the future.
Hot IPOs are often oversubscribed. This means market demand significantly surpassed the supply of shares, which raises the stock price once it is offered on the market.
Getting an IPO allocation is nearly beyond the reach of small investors. The only way to get one is to wait until the stock is listed on an exchange. Small investors are also told to wait for two days for the stock price to stabilize, instead of buying the IPO shares right away.
Determine the IPO Price
Determining the IPO price can be based on the company’s goal, the road show’s success rate, and current market situation. The firm must also select the stock exchange where its shares are going to be listed.
Determining the offer price is vital, as this will help the company raise capital for itself. However, once the stock starts trading on the secondary market, the money is raised from the sale of shares by the firm, rather than the underwriter.
Read the Primary Market and Secondary Market: Knowing their Differences to know more about the capital market.
The management sometimes will intentionally price the firm at a lower price to place the stock at more upbeat territory on the first day of trading. Businesses that declined after the first day usually have trouble regaining their initial price.
Select a Stock Exchange
Just like underwriters, stock exchanges will want the business of an IPO as well, since it can offer more trading opportunities and future dealings from other offers. There is also the chance of having a well-known company listed.
Exchanges state their offer to the bank and the company with the underwriting will then make the decision.
Once the business has been listed, the firm will issue a press release announcing the availability of shares to the public. The stock can start trading and the general public can buy and sell shares.
Going public also means the company will have to follow the guidelines of the SEC. That means the firm is required to abide by the disclosure rules. This includes reporting regularly about its financial condition, granting the agency access to its trading practices, and holding shareholder meetings. The company will also have to undergo SEC quiet period for at least 25 days after the stock starts trading; 40 days in the case of larger firms. This period gives everyone time to access important details about the IPO process. The quiet period begins when the registration statement is made effective.
Investment banks, which are part of the underwriting group, are prohibited from disclosing research materials to the public at this time. On the other hand, banks that are not involved in the underwriting IPO process may issue research any time.
IPO fees usually range from 3 percent to 7 percent. The fee will depend on the size of firm, reputation, and how much additional work and risks the investment banks have to take care of to sell it. For a $100 million IPO, for example, banks could possibly make $7 million.
Investment banks provide the money to finance the IPO and purchases the shares of the firm before they get listed on an exchange. They profit through the difference in price between what they paid before the offering, and when the shares become available to the public.
Competition among banks for managing an IPO could get intense, depending on the company and the amount the bank believes it will be able to acquire from the deal.
How can you tell if an IPO is successful?
The following metrics can be used to determine the success of an IPO:
Within 30 days of the IPO, the company’s market capitalization must be able to level or exceed the market cap of its competitors to consider the offer successful.
The IPO process is deemed successful, when the difference between the offering price and market cap of the issuing firm 30 days after the IPO is below 20 percent. If not, then the IPO’s performance will be in question.
What is an IPO to the Stock Market and Economy?
IPOs are like an indicator of the stock market’s and economy’s health. During a recession, the number of IPOs could lessen since it is not worth it, when share prices are down. If the IPOs increase, it is suggesting that the economy is recovering.
Companies go public with the goal of raising huge amount of money in exchange for securities. That is called an IPO process.
Accomplishing an IPO would require the right investment bank, the SEC’s approval, investors, an acceptable price, and a stock exchange that best meets the firm’s stock listing needs.
The IPO process should not be taken lightly. Interested parties take this seriously, as there is a significant amount of money at risk.
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