nice piece on IPO process for beginners -
* SMART!IPO COMMENTARY **
UNDERSTANDING THE IPO PROCESS: WHY, WHEN AND HOW A COMPANY GOES
PUBLIC
<> Overview
The IPO market continues to sit in "hibernation-mode," as the
IPO calendar remains ultra-thin and as almost no companies are
filing their registration materials with the U.S. Securities and
Exchange Commission, which is the first step in the IPO process.
As we noted above, the reason is simple – investors are
exhausted. The markets have been in decline for months now and
the start of the New Year has not proven much different. On the
other hand, many Wall Street observers continue to speculate
that the IPO market could come back with a bang upon a rebound
of the broader market indices, which could be on the near-term
horizon.
To the extent that more companies seek to make their public
debuts if the markets turn around in short order, then investors
will need to be informed as to how best to participate in the
IPO process. For that reason, we have dedicated this issue of
the Smart!IPO Report to a discussion of why, when and how a
company goes public. We believe that this analysis will go a
long way towards informing investors on how best to position
themselves as successful players in the IPO market.
Going public represents a rite of passage for a company,
bestowing upon it significant benefits, including increasing the
ability of the company to expand, obtain future financing and
engage in strategic acquisitions. Corporations issue either
debt securities (e.g. bonds) or equity (e.g. stock) when they
need to raise capital. If the corporation previously has never
sold stock, the offering of its securities to the public is
known as an "Initial Public Offering" (IPO).
>From the perspective of investors, IPOs allow the public to
"own" a piece of a previously private company that the investor
believes has promise to succeed. Notwithstanding the recent
slowdown in the IPO market as the end of the year approached,
Wall Street's insatiable appetite for new issues is expected to
resume upon a rebound in the markets. But which IPOs will be
most attractive to individual investors? The following analysis
of why, when and how a company goes public will help investors
decide which new issues are best positioned to succeed in the
IPO process.
<> Selection of an Underwriter
The first step for the company desiring to go public is to hire
an investment bank. The investment bank will act as the
company's advisor and will often serve as an underwriter for the
IPO. Underwriting is the actual process of raising capital
through debt or equity.
Selecting an underwriter is a crucial step for the company in
the IPO process. It is helpful to choose an underwriter that
has taken other companies public in the same industry, which is
likely to facilitate (i) the pricing of the issue, (ii) the
selling of the offering to a syndicate and (iii) the
communication and relationship with analysts who cover the
industry. While some underwriters specialize in certain
industries, others specialize in, among other things, debt or
equity offerings, and large or small cap corporations.
As a general rule, the higher the quality of the investment
bank, the more shares of a company's stock it will hold as it
makes a market for the stock in the aftermarket. The
underwriter should demonstrate a strong desire to make a market
in the stock. This is particularly important to avoid huge
fluctuations in the price of the stock in the aftermarket and to
provide liquidity for investors who desire to buy, or
shareholders who want to sell their shares.
In selecting an underwriter, the company must consider several
factors relating to the offering, including the amount of
capital needed by the corporation, the type of security to be
issued, the price of the security, any special features of the
security and the cost to the firm to issue the securities. If
the company and the underwriter agree on these key factors, the
investment bank will be retained to act as the "middleman"
between the corporation and the general public during the IPO
process.
<> Filing of a Registration Statement
When a company is taken public, it must first file with the U.S.
Securities and Exchange Commission (SEC) a registration
statement in order to comply with federal securities laws. The
registration statement contains information that is important
for potential investors to consider in determining whether to
invest in the company, including (i) a description of the
company, (ii) biographical material on the officers and
directors of the company, (iii) the amount of shares each
insider (officers, directors and shareholders owning more than
10% of the securities) owns, (iv) financial statements of the
company and (v) a description of any legal proceedings involving
the company.
<> The "Cooling Off" or "Quiet" Period
Following the filing of the registration statement by the
company, the SEC requires a "Cooling Off" or "Quiet" period
during which time the SEC investigates whether the company has
disclosed fully to investors all relevant information that they
would need to determine whether to invest in the company.
During the quiet period, the company's management is prohibited
from making certain statements to the public and any information
that the company includes in speeches, press releases, brochures
and advertising (and even discussions by management with family
or friends relating to the offering), could be construed as
releasing inappropriate information. Any misstep could set the
offering back and subject the company or the disclosing
individual to sanctions. Specific information that can be
released to the public during the quiet period includes the name
of the issuer, the title of the securities, the amount of the
offering, a brief description of the business and identification
of the company's principal officers.
<> The Road Show
The investment bank uses the quiet period to drum up interest in
the IPO among potential investors in the company. About one
month prior to the date that the company actually goes public,
its management team goes on the road for the "Road Show" and
coordinates meetings in several different cities where brokers,
analysts, portfolio managers and institutional traders question
them about the IPO. The purpose of these meetings is to (i)
highlight the company to potential investors who might improve
the price performance of the company's stock in the aftermarket
and (ii) see how well the management team holds up under intense
questioning by seasoned professionals.
During the road show, the company's management is required to
present both the positive and negative aspects of the company
and must explain their market position and how the business plan
will be executed. While the participants may be provided with
historical information about the company, including historic
earnings growth, revenue growth, R&D expenditures, market share
gains, and other financial results, the management is prohibited
from making forecasts, projections or any forward-looking
statements about the company during the quiet period.
The investment bank will distribute during the road show a
"preliminary prospectus," which is intended to familiarize
potential investors with the corporation. The preliminary
prospectus contains much of the information contained in the
registration statement. The public offering price (the price at
which the company's shares will be sold in the IPO) is not known
during the road show period and is not contained in the
preliminary prospectus; rather, the price is determined when the
registration statement is finalized so that the company's shares
in the IPO will be priced in accordance with current market
conditions.
Investors should be aware that if they are interested in
investing in the company, they can give their stockbroker
"indications of interest" in the IPO. The stockbroker cannot,
however, take an order for the issue from the client. The
higher the indication of interest from potential investors, the
easier it is for the investment bank to make pricing decisions –
and usually the higher the price will be.
<> Pricing of the IPO
Once the road show ends and the final prospectus is printed and
distributed to investors, company management meets with the
investment bank to choose the final offering price and size of
the issue. The investment bank will set a price based on
expected demand for the issue and a host of other market
conditions. The pricing of an IPO is a delicate balancing act.
Investment firms have to focus on the desires of two different
sets of clients -- the company going public, which wants to
maximize the amount of money it raises, and the investors buying
the company's shares, who expect to see some immediate
appreciation in their investment. While the opening premium
usually is about 15%, several hot Internet IPOs have been priced
to allow for far greater premiums.
In less common cases, companies postpone their offerings when
demand for their shares is insufficient. This can result from
investors' concerns about the company's prospects going forward,
or from general concerns about the market. This has been true
during recent weeks, as many companies have withdrawn their
scheduled initial public offerings amid the tenuous market
environment.
<> Public Trading of the New Issue
Once the offering price has been agreed to -- and at least two
days after potential investors receive the final prospectus --
the IPO is declared effective by the SEC. This is usually done
the night before the IPO when trading ends on the market on
which the company's new shares will be traded publicly. Trading
of the new stock will start the next day as the lead underwriter
works to firm up its book of buy orders. It is at this point
that investors will often begin to see large gains made in the
company's stock from the initial price of the offering, and from
the initial trading price following the offering. |
