Investopedia.com
IPOs- initial public offering: first offering of stock by a company to the public.
If the company has never issued equity to a company….it is an IPO
A privately owned company may need more funds than it can get from borrowing so it will turn to an IPO
Private and public companies
Private: most small businesses, usually cant buy shares, only invest in, dont have to share information
Also referred to as “going public”
Public: atleast sold a portion of themselves to the public and trade on the stock exchange, have thousands of shareholders and are subject to strict rules and regulations, must have a board of directors and report financial info every quarter
Why go public?:
-better rates when issuing debt
-can always issue more stock as long as there is a market in demand
-trading in the open market means liquidity = you can implement things like employee stock ownership plans, which help attract top talent
1st step is to obtain private equity funding from VC firms
VC firms: venture capitalist firms, invest in firms that offer high potential for growth over time. prefer 2-5 years investment periods
Developing a prospectus:
Contains detailed info about the firm and includes financial statements and the risks involved. Intended to provide potential investors with the information they need to decide whether to invest in the firm.
Submits a copy to the SEC Securities and Exchange Commission and they decide whether is contains all of the necessary information. Once approved, it is sent to institutional investors who might want to invest in the IPO.
Road Show: firms managers travel to various cities and meet with institutional investors and give presentations. They target institutional investors because they will be willing to buy large blocks of shares at the time of the IPO. Therefore they have priority over individual investors.
Pricing:
Offer price: price at which the shares will be offered at the time of the IPO
Bookbuilding: on the road show the lead underwriter solicits indications of interest in the IPO by institutional investors as to the number of shares they may demand at various possible offer prices. Then the underwriter decides at which price they will be able to sell the shares.
Transaction cost: usually 7% so an IPO of 50 million would have a transaction cost of 3.5 million.
Price Stability:
If the investors quickly sell their IPO stock into the secondary market, there will be downward pressure on the stocks price.
In order to prevent that the underwriter should require a lockup provision, which prevents the firms from selling their shares for a specific period. Usually 6 months. In reality, the lockup provision only defers the possible excess supply of shares in the secondary market.
Timing of IPOs: IPOs tend to occur more frequently when the market is bullish (when you think the prices are going to rise)