What is an IPO?
Before getting into the definition of an IPO, let’s understand what a private company is. Investopedia likes to think of private companies as “a company that is held under private ownership”. This means although the company issues stock, it is not traded on public exchanges. It is owned by the stakeholders of the company itself. These shares are less liquid and their valuation is more difficult to determine.
However, when a company wants to go from private to public (make available a certain chunk of their total stock to the public), they do so by a process called the Initial Public Offering or IPO.
It is defined as selling the stock of the company to the public in the primary market in order to raise capital investment by offering its stock to the public for the first time. Most IPO’s are done by growing companies seeking capital. It happens when the issuer or company looking to raise capital brings an underwriting firm or an investment banking service in India to decide what type of security to sell, the offering price and the time frame of the IPO.
Why does a company go public?
Companies usually go public in order to raise investment capital – it’s a money-making move. The essence of the intent behind an IPO is to raise funds and have more liquidity (instant cash on hand) by selling the shares to people. This money is then used to re-invest in new projects, business operations, company infrastructure or even expanding the business.
These public shares are also used as incentives or perks to give to top management executives and officers. One such perk is a stock option plan or ESOP’s. This stock is also used during mergers and acquisition deals as a payment option.
The IPO process
Being an IPO-registered business means that you are exposing part of your company’s stock to the public, also termed as “going public”. Since it is the first time that the company owners will sell a part of their ownership which is kind of a big deal, the company has to undergo a process to make go public.
Picture credits: www.foundersguide.com
Let’s get into the meat of the IPO process. It involves 8 steps :
- Having a trustworthy management team: Going public is a fairly complicated process involving a ton of metrics and calculations. It can get pretty sticky. Thus, it is always a great idea to employ the right people to maneuver the process. They must be able to handle the investors, answer SEC queries and be able to clearly communicate the companies vision.
- Have your companies financials ready: Going public requires a complete disclosure of the financial health of the company by employing sharp finance and accounting personnel. The company must have a credible system to ensure all the data is consistent, accurate and stored in chronological order.
- Choosing investment bankers: Although it’s possible for the company to sell their shares on their own, they usually hire investment banks or an IPO advisory service to handle to IPO. Investment banks can work together in a group or alone on an IPO. This is done by forming a group of banks and investors to spread the funding of the IPO. Their main job is to look for and to approach potential investors.Banks submit bids to companies going public articulating the returns that they can make with the public offering and how what percentage of the returns the bank will get as commission. This process is called underwriting. The bank and the company then estimate how much money they can raise, the type of security being traded and other details of the underwriting agreement. Some of the biggest investment banks are Goldman Sachs and Morgan Stanley.
- Writing your company’s story: Telling your companies story, as well as its long-term and short-term future plans, gives your potential investors a chance to look at the company’s journey so far as well as their vision for the company’s future. Your story should include the Your goal, Your mission and Your vision. You must articulate your strengths, market opportunities and Reasons why your company will be a good investment in the Long run.
- Register with the SEC:After an agreement between the company and banks is confirmed, the bank processes a registration statement to be filed with the SEC. The statement contains company financials including its balance sheet, cash flow statements, etc., background of the management, legal issues if any, current shareholders, etc. The SEC will study the statement in detail and do their due diligence to ensure that all the information submitted to it is correct and all the financial data is disclosed and not hidden.If everything so far is aright, the SEC will set a date, agreed upon by the company for the IPO distribution. The underwriter or investments bank must put create a prospectus that contains the financial information of the company itself.
- The road show: Once the company has fully complied with SEC’s comments and recommendations, if any, they can finally go ahead and meet their potential investors. The underwriters present the prospectus to prospective investors. Usually, interactions with investors happen at meetings, press conferences, investor visits to introduce your company and the advantages of investing in it, or even trips all around the world by underwriters. If an investor likes the IPO, the underwritersoffer them the shares at the price set before the stock is listed. This process is known as IPO allocation.
- Pricing your IPO: After completely screening the company and creating your potential investor list, the company’s board of directors and underwriters infer a value which becomes the price per share of the stock.
- Get ready to be a publically-owned company: Most IPO’s usually close within 3-4 business days. The underwriters buy the shares usually at a 7% discount or lesser. The issuers undergo a 25-day period called “quiet period” where brokers approach and provide IPO-sales materials to investors.
Finally, when the firm goes public, it falls under the SEC guidelines. It has to now comply with its rules like holdings and transactions of insiders as well as officers and top level directors of the company. The company has to disclose their financial documents on a regular basis (quarterly) and be under the the watch of the SEC. It will always have to hold periodic meetings with the shareholders.