Entrepreneurship University
College of Entrepreneurial Studies (CES)

Initial Public Offerings

The IPO Process

When a company sells stock to the public for the first time it is called an initial public offering. Stock is sold in the primary market at an offering price determined by the IPO team. Following the financing, the shares are traded in the secondary market or “aftermarket.” Selling stock in the primary market is assisted with investment bankers or underwriters that help promote the potential offering.

Why does a company go public?

Most people label a public offering as a marketing event, which it typically is. When a company files for registration withe the Securities and Exchange Commission, the company must list what the proceeds from the offering are to be earmarked for. In most cases, proceeds will help pay down debt and fund expansion. Prospectuses for all US companies are available for free from the Securities and Exchange Commission’s Web site FreeEDGAR.com. See Facebook’s registration as an example.

The process for an IPO requires lengthy and expensive paperwork and a full review by the SEC. Registration documents include detailed disclosure, historical financial statements, and third party audits that take time to assemble. The process requires many hours of assistance by attorneys and accountants, and the SEC review can last from 20 to 60 days. Registration alone can cost a business thousands of dollars even before the offering makes any money.

For the majority of firms going public, they need additional capital to execute long-range business models, increase brand name and utilize funds for possible acquisitions. This is typical of today’s Internet and technology offerings. By converting to corporate status, a company can always dip back into the market and offer additional shares through a secondary offering.

Assuming that your company meets the qualifications, let us begin looking at some of the preparatory work involved.

Getting ready

A company that is thinking about going public should start preparing detailed financial results on a regular basis, and developing a business plan if they do not already have one, as much as two years in advance of the desired IPO. Soon thereafter, it needs to put its IPO team together, consisting of the lead investment bank, an accountant, and a law firm.

The IPO process officially begins with what is typically called an “all-hands” meeting. At this meeting, which usually takes place six to eight weeks before a company officially registers with the Securities and Exchange Commission, all the members of the IPO team plan a timetable for going public and assign certain duties to each member.

The prospectus

The most important and time-consuming task facing the IPO team is the development of the prospectus, a business document that basically serves as a brochure for the company. The prospectus includes all financial data for a company for the past five years, information on the management team, and a description of a company’s target market, competitors, and growth strategy. There is a lot of important information in the prospectus, and the underwriting team must make sure it is accurate.

Once the preliminary prospectus is printed and filed with the SEC, the company has to wait as the SEC, the National Association of Securities Dealers (NASD), and other relevant state securities organizations review the document for any omissions or problems. If the agencies find any problems with the prospectus, the company and the underwriting team will have to fix them with amended filings.

In the meantime, the lead underwriter must then assemble a syndicate of other investment banks that will help sell the deal. Each bank in the syndicate will get a certain number of shares in the IPO to sell to clients. The syndicate then gathers indications of interest from clients to see what kind of initial demand there is for the deal. Syndicates usually include investment banks that have complementary client bases, such as those based in certain regions of the country.

The road show

The next step in the IPO process is known as the road show. The road show usually lasts a week or two, with company management meeting with prospective investors to present their business plan. The show usually goes to major financial centers, such as New York, San Francisco, Boston, Chicago, and Los Angeles. If appropriate, international destinations like London or Hong Kong may also be included.

Once the road show ends and the final prospectus is printed and distributed to investors, company management meets with their investment bank to choose the final offering price and size. Investment banks try to suggest an appropriate price based on expected demand for the deal and other market conditions. The pricing of an IPO is a balancing act. Investment firms have two sets of clients — the company going public, which wants to raise as much money as possible, and the investors buying the shares, who expect to see some immediate appreciation in their investment.

If interest in an IPO is weak, the number of shares in the offering or their price may be cut from the expected ranges. If it is strong, the offering price or size can also be raised from initial expectations. A company can also postpone an offering because of insufficient demand.

Beginning trading

Once the offering price has been agreed on, and at least two days after potential investors receive the final prospectus, an IPO is declared effective. This is usually done after a market closes, with trading in the new stock starting the next day as the lead underwriter works to confirm its buy orders.

The lead underwriter is primarily responsible for ensuring smooth trading in a company’s stock during those first few crucial days. This could mean supporting the price of a newly issued stock by buying shares in the market, or by selling them short (which means selling shares it doesn’t have in its account).

An IPO is not declared final until about seven days after the company’s market debut. On rare occasions, an IPO can be canceled even after a stock starts trading. In such cases, all trading is negated and any money collected from investors is returned.

Costs involved in going public

An excellent Roadmap for an IPO is published by PWC.

According to Reference for Business,

One disadvantage of going public is that it is extremely expensive. In fact, it is not unusual for a business to pay between $50,000 and $250,000 to prepare and publicize an initial public stock offering. In his article for The Portable MBA in Finance and Accounting, Paul G. Joubert noted that a business owner should not be surprised if the cost of an IPO claims between 15 and 20 percent of the proceeds of the sale of stock.

Some of the major costs include the lead underwriter’s commission; out-of-pocket expenses for legal services, accounting services, printing costs, and the personal marketing “road show” by managers; .02 percent filing costs with the SEC; fees for public relations to bolster the company’s image; plus ongoing legal, accounting, filing, and mailing expenses.

Despite such expense, it is always possible that an unforeseen problem will derail the IPO before the sale of stock takes place. Even when the sale does take place, most underwriters offer IPO shares at a discounted price in order to ensure an upward movement in the stock during the period immediately following the offering. The effect of this discount is to transfer wealth from the initial investors to new shareholders.

These costs don’t go away. Every year hence, there will be audit fees, legal fees, quarterly reports, proxy reports, miscellaneous filings, annual reports, transfer agent fees, public relations, investor relations, and a whole host of other expenses relating to being a public company.

Wishing you success,

John B. Vinturella, Ph.D.

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