IPO's Explained

An IPO (Initial Public Offering) marks the first time a private company issues shares to the public, becoming a publicly listed company in the process. The aim is simple: raise capital, boost awareness and boost further growth. This article explains that process.

Using the brilliant IPO explainers written by WallStreetPrep, Investopedia and CFI, as well as The Plain Bagel’s YouTube video, I created the following 5 step guide to the IPO process.

5 Step IPO Process

1.        Select Underwriters

2.        Due Diligence & Documents

3.        Roadshow

4.        Pricing & Share Allocation

5.        Going Public & Aftercare

Step 1) Select Underwriters

The company hires an investment bank (or banks) to manage the IPO. These banks act as middlemen and essentially complete the process on behalf of the company. The banks attempt to raise the maximum amount of capital with the total shares being issued.

Step 2) Due Diligence & Documents

This is the longest part of the process. The company is scrutinised by accountants, lawyers and bankers. They ensure the books are clean, the risks are known and practically the whole company and deal is dissected. In the U.S., an official registration statement called a ‘red herring prospectus’ is then sent to the U.S. Securities and Exchange Commission (SEC) who must approve the document before shares are sold. Similarly, in the UK an IPO Prospectus is published and gets approved by the FCA.

For more information on the process, please check the FCA handbook and SEC Investor.gov  website.

Step 3) Roadshow

This is where the fun really begins. The company’s directors attempt to market their stocks. They’ll set up meetings with investment firms such as hedge funds and asset managers to showcase their company and explain why investing in their company is such an attractive deal. Investors will  then send the company an indication of interest (IOI), letting them know how much stock they wish to buy.

Step 4) Price & Share Allocation

Once investor interest has been gauged, bankers and the company leadership set the IPO price (share price) and IPO allocation (how many shares are being sold) is decided. They want to maximise capital while also ensuring all shares are sold so picking the correct price is crucial!

Step 5) Going Public & Aftercare

On IPO day, shares are officially issued and the company is listed on public stock exchanges for the first time. For a short period of time after this, underwriters will do ‘stabilising activities’ in an effort to reduce stock volatility. This involves manipulating the market through buying and selling extra shares using a ‘Greenshoe clause.’ A clause enabling underwriters to sell more shares than originally planned. If the stock price falls below the share price, underwriters buy back shares hoping to create market pressure to stabilise the stock.

Pros

·      Raises capital for further growth

·      Provides original stakeholders liquidity, allowing them to now sell their shares

·      Increases visibility and so boosts public image

Cons

·      Market state dictates IPO’s, poor timing can be disastrous

·      Being public increases regulation and reporting requirements

If you found this useful, feel free to check out the rest of my content, all written to help make finance simple!