Initial Public Offering(IPO)

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IPO is divided into three words.

  • Initial- It means for the first time.
  • Public- It includes retail investors, institutional investors, and other corporations.
  • Offering- Wants to share the part of their profit.

All together, IPO means a company is going to offer its shares for sale to the public for the first time. Through buying the company’s shares you can become the owner and can get a piece of profit cake.

The first modern IPO was offered to the public by a company named Dutch East India Company in March 1602. Since then the company has used IPO as a way to raise capital from the public.

The all-time largest IPO is by Saudi Aramco in 2019 with a deal size of $25,599 million.

What are the advantages for a company to go public?

  • To access the funds required to expand their current operations or fund any existing project.
  • To fund an acquisition.
  • To redeem an existing debt or fund their day to day operations.
  • To provide liquidity to its founders or private investors.
  • IPO helps in increasing the transparency and credibility of a company, which makes it easier to raise capital in the future.
  • When a company begins the process of IPO it gets into the limelight, which is good for their product’s marketing and opening up new opportunities to attract clients.
  • The capital does not have to be repaid and does not involve an interest charge.

What are the disadvantages for a company to go public?

  • Going public is an expensive affair. A company needs to hire underwriters, investment bankers, auditors, and CPAs do road-shows, filing costs by SEC. The cost can range from $50k-$250k.
  • While registering for IPO with regulators a company has to reveal financial, business, and much other private information, which can be misused by their competitors.
  • There is always a risk for a firm to go public and yet not raise any additional new capital for the firm itself.
  • There is an increased risk of legal or regulatory issues.
  • There can be management shareholder conflict issues. Large shareholders may seek representation on the board and force management to take a particular decision. If enough shareholders become dissatisfied with the company’s stock value or future plans, they can stage a takeover and oust management.

What’s the procedure for going public in the USA?

In the United States, IPOs are regulated by the Securities and Exchange Commission under the Securities Act,1933.

  • A company has to register its statements with the Security Exchange Commission by filling out Form S-1. The statement includes a business summary, financial statements, risk factors, management’s compensation, how the fund will be used, how many shares are being offered. Registration statements also must include financial statements audited by an independent certified public accountant. All the data should comply with Generally accepted accounting principles (GAAP) and other SEC accounting requirements.
  • Once required documents are submitted SEC’s staff will review the data and if everything goes smooth they will declare the statements “effective”.
  • The company has to select underwriters who act as a mediator between the company and the capital markets. They also approach institutions and investors to create initial interest in the IPO in what is called the “roadshow".
  • There are three basic types of underwriting arrangements:

Best efforts — Under this agreement an investment bank doesn’t commit to buy any unsold shares but agrees to put forth its best effort to sell as many as possible.

All or none — It’s similar to best efforts except that the offering is canceled if all the shares are not sold

Firm commitment — Under this agreement an investment bank purchases all the shares itself. It’s generally beneficial for small companies.

  • A company planning an IPO typically appoints a lead manager, known as a book-runner. They help to discover the price at which the shares should be issued. There are two primary ways in which the price of an IPO can be determined. Either the company, with the help of its lead managers, fixes a price range, or the price can be determined through analysis of confidential investor demand data compiled by the book-runner. IPO prices can be under-priced or over-priced. Both have their own pros and cons.
  • Once everything looks good, the company gets a green signal from the SEC.

You can find the list of previous and upcoming IPOs on NASDAQ and NYSE.

Points to consider before investing in an IPO:

  • Don’t get swept away with the hype of a company. There are many companies that start with a bang but fail within the next few years.
  • Before investing, be sure to do your own due diligence. An investor should refer to the company’s preliminary prospectus known as a “red herring”. It includes information of underwriters, the company’s management team, competitive landscape, the company’s financials, who is selling shares in the offering, who currently owns shares, expected price range, potential risks, and the number of shares to be issued.
  • Do understand the industry in which they exist and who are the competitors.
  • Understand how a company’s product or service can stand out among other players in the industry.
  • For many retail investors, a late-stage IPO may often prove a better investment. By waiting for several months you can let the volatility work itself out of the market, and you will not be competing with large firms for the initial tranche of shares. While you may miss out on the occasional explosive-value offering, it is likely the far safer play in the long run.

Recent development related to the listing:

Nasdaq Inc. filed a proposal to adopt new listing rules, aiming to require board diversity and disclosure. Once SEC approves it all the listed companies on the Nasdaq exchange will have to publicly disclose “consistent, transparent diversity statistics” regarding their board of directors. Also, these companies would have to have or explain why they don’t have, at least two “diverse” directors, including one female and one who self-identifies as either “an underrepresented minority” or LGBTQ+.

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