Initial Public Offerings or IPOs
What is it?
According to Investopedia, an initial public offering, or IPO, refers to the process of offering shares of a private corporation to the public in a new stock issuance. Companies must meet requirements by exchanges and the Securities and Exchange Commission (SEC) to hold an IPO.
IPOs provide companies with an opportunity to obtain capital by offering shares through the primary market.
Companies hire investment banks to market, gauge demand, set the IPO price and date, and more.
An IPO can be seen as an exit strategy for the company’s founders and early investors, realizing the full profit from their private investment.
To be really clear, news about this mostly involves the stock market, but it does not have to be limited to that.
In English, we have company A, which wants to have more money with which to do presumably good things. They have either exhausted the supply of private investors, or they've tired of that game, or some other reason which makes raising money from you and me, the public, more attractive.
To do this, they have to give us something we value in return for something they value.
In this case, we value owning a piece of them, and they value our money. They also value their public image.
This is an IPO. The first time such an exchange, the partial ownership of company A in return for our money, happens. Later today, or tomorrow, or any other time beyond that, and company A is said to be, "trading in the secondary market", or is changing hands from one person who is not the first owner to another person who is also not the first owner. The cost which occurs at that time is often based on people's future expectations then, which could be higher, could be the same, or could be lower.
What's the difference between a primary market and a secondary market?
A primary market is where the company sells its shares directly to investors.
A secondary market is where investors buy shares from other investors.
The IPO Process
An IPO comprehensively consists of two parts. The first is the pre-marketing phase of the offering, while the second is the initial public offering itself. When a company is interested in an IPO, it will advertise to underwriters by soliciting private bids or it can also make a public statement to generate interest.
The underwriters lead the IPO process and are chosen by the company. A company may choose one or several underwriters to manage different parts of the IPO process collaboratively. The underwriters are involved in every aspect of the IPO due diligence, document preparation, filing, marketing, and issuance.
Key IPO Terms
Like everything in the world of investing, initial public offerings have their own special jargon. You’ll want to understand these key IPO terms:
Common stock: When going public, a company offers shares of common stock for sale.
Issue price: The price at which shares of common stock will be sold to investors before an IPO company begins trading on public exchanges. Commonly referred to as the offering price.
Lot size: The smallest number of shares you can bid for in an IPO. If you want to bid for more shares, you must bid in multiples of the lot size.
Preliminary prospectus: A document created by the IPO company that discloses information about its business, strategy, historical financial statements, recent financial results and management. It has red lettering down the left side of the front cover and is sometimes called the “red herring.”
Price band: The price range in which investors can bid for IPO shares, set by the company and the underwriter. It’s generally different for each category of investor. For example, qualified institutional buyers might have a different price band than retail investors like you.
Underwriter: The investment bank that manages the offering for the issuing company. The underwriter generally determines the issue price, publicizes the IPO and assigns shares to investors.
Steps to an IPO
1. Proposals
Underwriters present proposals and valuations discussing their services, the best type of security to issue, offering price, amount of shares, and estimated time frame for the market offering.
2. Underwriter
The company chooses its underwriters and formally agrees to underwrite terms through an underwriting agreement.
3. Team
IPO teams are formed comprising underwriters, lawyers, certified public accountants (CPAs), and Securities and Exchange Commission (SEC) experts.
4. Documentation
Information regarding the company is compiled for required IPO documentation. The S-1 Registration Statement is the primary IPO filing document. It has two parts—the prospectus and the privately held filing information.1
The S-1 includes preliminary information about the expected date of the filing.2 It will be revised often throughout the pre-IPO process. The included prospectus is also revised continuously.
5. Marketing & Updates
Marketing materials are created for pre-marketing of the new stock issuance. Underwriters and executives market the share issuance to estimate demand and establish a final offering price. Underwriters can make revisions to their financial analysis throughout the marketing process. This can include changing the IPO price or issuance date as they see fit.
Companies take the necessary steps to meet specific public share offering requirements. Companies must adhere to both exchange listing requirements and SEC requirements for public companies.
6. Board & Processes
Form a board of directors and ensure processes for reporting auditable financial and accounting information every quarter.
7. Shares Issued
The company issues its shares on an IPO date. Capital from the primary issuance to shareholders is received as cash and recorded as stockholders' equity on the balance sheet. Subsequently, the balance sheet share value becomes dependent on the company’s stockholders' equity per share valuation comprehensively.
8. Post IPO
Some post-IPO provisions may be instituted. Underwriters may have a specified time frame to buy an additional amount of shares after the initial public offering (IPO) date. Meanwhile, certain investors may be subject to quiet periods.
How does the process differ between companies with different capitalization levels?
Companies with larger amounts of capitalization tend to have less risk than smaller companies.
Companies with large amounts of capitalization have many ways to make money. They can sell products, services, or anything else they produce.
In addition, they can earn interest on their cash reserves.
Companies with small amounts of capitalization must rely on one thing: selling shares.
This means that they need to offer something people want in order to survive.
In general, companies with larger amounts of capital have better chances of surviving because they are more likely to be successful at making money.
Is there an advantage to going public early?
Going public early gives you access to money from investors.
However, it also limits your ability to grow as fast as possible.
For example, if you go public too soon, you might not have enough money to pay back your debtors.
You could also lose some of your stock value when you go public early.
However, this doesn't mean that you shouldn't try to go public early.
It just means that you should weigh the pros and cons carefully before deciding to go public.
Why would someone want to invest in a private company?
Investing in a private company allows you to benefit from the growth of the company without having to take on any of the risks associated with starting a business yourself.
Investing in a private company also lets you avoid paying taxes on income earned from investments.
Private companies don't have to report their earnings to the government.
Private companies also usually aren't required to file financial reports with the SEC.
These things make investing in private companies easier.
But, private companies also have disadvantages.
They're not subject to the same regulations as publicly traded companies.
They can't raise money through the sale of securities.
And, they may not be able to issue dividends.
When do I get my first check?
Your first check will come after the IPO.
It will include a dividend payment based on the amount of equity you own.
The amount of the dividend depends on the size of the company's initial public offering price.
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