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Initial public offering
An initial public offering (IPO) is the first sale of a corporation's common shares to investors on a public stock exchange.
The main purpose of an IPO is to raise capital for the corporation.
While IPOs are effective at raising capital, being listed on a stock exchange imposes heavy regulatory compliance and reporting requirements.
The term only refers to the first public issuance of a company's shares.
If a company later sells newly issued shares again to the market, it is called a "Seasoned Equity Offering".
When a shareholder sells shares, it is called a "secondary offering" and the shareholder, not the company who originally issued the shares, retains the proceeds of the offering.
These terms are often confused.
In distinguishing them, it is important to remember that only a company, which issues shares can make a "primary offering".
Secondary offerings occur on the "secondary market", where shareholders (not the issuing company) buy and sell shares from and to each other.
Reasons for listing
Procedure
Business cycle
Auction
Pricing
Quiet Period
See also
External links
References
Reasons for listing
When a company lists its shares on a public exchange, it will almost invariably look to issue additional new shares in order to raise extra capital at the same time.
The money paid by investors for the newly-issued shares goes directly to the company (in contrast to a later trade of shares on the exchange, where the money passes between investors).
An IPO, therefore, allows a company to tap a wide pool of stock market investors to provide it with large volumes of capital for future growth.
The company is never required to repay the capital, but instead the new shareholders have a right to future profits distributed by the company.
The existing shareholders will see their shareholdings diluted as a proportion of the company's shares.
However, they hope that the capital investment will make their shareholdings more valuable in absolute terms.
In addition, once a company is listed, it will be able to issue further shares via a rights issue, thereby again providing itself with capital for expansion without incurring any debt.
This regular ability to raise large amounts of capital from the general market, rather than having to seek and negotiate with individual investors, is a key incentive for many companies seeking to list.
Procedure
IPOs generally involve one or more investment banks as "underwriters."
The company offering its shares, called the "issuer," enters a contract with a lead underwriter to sell its shares to the public.
The underwriter then approaches investors with offers to sell these shares.
The sale (that is, the allocation and pricing) of shares in an IPO may take several forms.
Common methods include:
Dutch auction
Firm commitment
Best efforts
Bought deal
Self Distribution of Stock
A large IPO is usually underwritten by a "syndicate" of investment banks led by one or more major investment banks (lead underwriter).
Upon selling the shares, the underwriters keep a commission based on a percentage of the value of the shares sold.
Usually, the lead underwriters, i.e. the underwriters selling the largest proportions of the IPO, take the highest commissions—up to 8% in some cases.
Multinational IPOs may have as many as three syndicates to deal with differing legal requirements in both the issuer's domestic market and other regions.
For example, an issuer based in the E.U. may be represented by the main selling syndicate in its domestic market, Europe, in addition to separate syndicates or selling groups for US/Canada and for Asia.
Usually, the lead underwriter in the main selling group is also the lead bank in the other selling groups.
Because of the wide array of legal requirements, IPOs typically involve one or more law firms with major practices in securities law, such as the Magic Circle firms of London and the white shoe firms of New York City.
Usually, the offering will include the issuance of new shares, intended to raise new capital, as well the secondary sale of existing shares.
However, certain regulatory restrictions and restrictions imposed by the lead underwriter are often placed on the sale of existing shares.
Public offerings are primarily sold to institutional investors, but some shares are also allocated to the underwriters' retail investors.
A broker selling shares of a public offering to his clients is paid through a sales credit instead of a commission.
The client pays no commission to purchase the shares of a public offering, the purchase price simply includes the built-in sales credit.
The issuer usually allows the underwriters an option to increase the size of the offering by up to 15% under certain circumstance known as the greenshoe or overallotment option.
Business cycle
In the United States, during the dot-com bubble of the late 1990s, many venture capital driven companies were started, and seeking to cash in on the bull market, quickly offered IPOs. Usually, stock price spiraled upwards as soon as a company went public, as investors sought to get in at the ground-level of the next potential Microsoft and Netscape.
Initial founders could often become overnight millionaires, and due to generous stock options, employees could make a great deal of money as well. The majority of IPOs could be found on the Nasdaq stock exchange, which lists companies related to computer and information technology. However, in spite of the large amounts of financial resources made available to relatively young and untested firms (often in multiple rounds of financing), the vast majority of them rapidly entered cash crisis. Crisis was particularly likely in the case of firms where the founding team liquidated a substantial portion of their stake in the firm at or soon after the IPO (Mudambi and Treichel, 2005).
This phenomenon was not limited to the United States. In Japan, for example, a similar situation occurred. Some companies were operated in a similar way in that their only goal was to have an IPO. Some stock exchanges were set up for those companies, such as Nasdaq Japan.
Perhaps the clearest bubbles in the history of hot IPO markets were in 1929, when closed-end fund IPOs sold at enormous premiums to net asset value, and in 1989, when closed-end country fund IPOs sold at enormous premiums to net asset value. What makes these bubbles so clear is the ability to compare market prices for shares in the closed-end funds to the value of the shares in the funds' portfolios. When market prices are multiples of the underlying value, bubbles are clearly occurring.
Auction
A venture capitalist named Bill Hambrecht has attempted to devise a method that can reduce the inefficient process.
He devised a way to issue shares through a Dutch auction as an attempt to minimize the extreme underpricing that underwriters were nurturing.
Underwriters, however, have not taken to this strategy very well.
Though not the first company to use Dutch auction, Google is one established company that went public through the use of auction.
Google's share price rose 17% in its first day of trading despite the auction method. Perception of IPOs can be controversial.
For those who view a successful IPO to be one that raises as much money as possible, the IPO was a total failure.
For those who view a successful IPO from the kind of investors that eventually gained from the underpricing, the IPO was a complete success.
It's important to note that different sets of investors bid in auctions versus the open market - more institutions bid, fewer private individuals bid.
Google may be a special case, however, as many individual investors bought the stock based on long-term valuation shortly after it launched its IPO, driving it beyond institutional valuation.
Pricing
Historically, IPOs both globally and in the US have been underpriced.
The effect of underpricing an IPO is to generate additional interest in the stock when it first becomes publicly traded.
This can lead to significant gains for investors who have been allocated shares of the IPO at the offering price.
However, underpricing an IPO results in "money left on the table"- lost capital that could have been raised for the company had the stock been offered at a higher price.
The danger of overpricing is also an important consideration.
If a stock is offered to the public at a higher price than what the market will pay, the underwriters may have trouble meeting their commitments to sell shares.
Even if they sell all of the issued shares, if the stock falls in value on the first day of trading, it may lose its marketability and hence even more of its value.
Investment banks, therefore, take many factors into consideration when pricing an IPO, and attempt to reach an offering price that is low enough to stimulate interest in the stock, but high enough to raise an adequate amount of capital for the company.
The process of determining an optimal price usually involves the underwriters ("syndicate") arranging share purchase commitments from lead institutional investors.
Note: Not all IPOs are eligible for delivery settlement through the DTC system, which would then either require the physical delivery of the stock certificates to the clearing agent bank's custodian, or a delivery versus payment ("DVP") arrangement with the selling group brokerage firm.
This information is not sufficient.
Quiet period
After the newly public company has its IPO, it enters a "quiet period."
During this time, the insiders, and any underwriters involved in the IPO, are restricted from issuing any earnings forecasts or research reports for the company.
The quiet period is in effect for 40 calendar days following the first trading day.
Regulatory changes by the United States Securities and Exchange Commission, changed the quiet period of 25 days, to 40 days on July 9, 2002.
When the quiet period is over, generally the lead underwriters will initiate research coverage on the firm.
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