A company that is thinking about going public should start acting like a public company as much as two years in advance of the desired IPO. Several steps experts recommend include preparing detailed financial results on a regular basis and developing a business plan.
Once a company decides to go public, it needs to pick its IPO team, consisting of the lead investment bank, an accountant, and a law firm.
The IPO process officially begins with what is typically called an “all-hands” meeting. At this meeting, which usually takes place six to eight weeks before a company officially registers with the Securities and Exchange Commission, all the members of the IPO team plan a timetable for going public and assign certain duties to each member.
Selling the deal
The most important and time-consuming task facing the IPO team is the development of the prospectus, a business document that basically serves as a brochure for the company. Since the SEC imposes a “quiet period” on companies once they file for an IPO — which generally lasts until 25 days after a stock starts trading — the prospectus will have to do most of the talking and selling for the management team.
The prospectus includes all financial data for a company for the past five years, information on the management team, and a description of a company’s target market, competitors, and growth strategy. There is a lot of other important information in the prospectus, and the underwriting team goes to great lengths to make sure it’s all accurate. We take a closer look at the prospectus
in part three of this series.
Once the preliminary prospectus is printed and filed with the SEC, the company has to wait as the SEC, the National Association of Securities Dealers (NASD), and other relevant state securities organizations review the document for any omissions or problems. If the agencies find any problems with the prospectus, the company and the underwriting team will have to make fixes with amended filings.
In the meantime, the lead underwriter must assemble a syndicate of other investment banks that will help sell the deal. Each bank in the syndicate will get a certain number of shares in the IPO to sell to clients. The syndicate then gathers indications of interest from clients to see what kind of initial demand there is for the deal. Syndicates usually include investment banks that have complementary client bases, such as those based in certain regions of the country.
On the road
The next step in the IPO process is the grueling whirlwind multicity world tour, also known as the road show. The road show usually lasts a week or two, with company management going to a new city every day to meet with prospective investors and show off their business plan.
The typical US stops on the road show include New York, San Francisco, Boston, Chicago, and Los Angeles. If appropriate, international destinations like London or Hong Kong may also be included.
How a company’s management team performs on the road show is perhaps the most crucial factor determining the success of the IPO. Companies need to impress institutional investors so that at least a few of them are willing to purchase a significant stake.
The road show is also the most blatant example of how unfair the IPO market can be for the average investor. Only institutional and big-money investors are invited to attend the road show meetings, where statements regarding a company’s business prospects — discussed only minimally in a prospectus — are talked about quite openly. According to the SEC, such disclosures are legal, as long as done orally.
The SEC hasd new rules that, ifapproved, will make it easier for companies to broadcast their road showsover the Internet.
Once the road show ends and the final prospectus is printed and distributed to investors, company management meets with their investment bank to choose the final offering price and size.
Investment banks try to suggest an appropriate price based on expected demand for the deal and other market conditions. The pricing of an IPO is a delicate balancing act. Investment firms have to worry about two different sets of clients — the company going public, which wants to raise as much money as possible, and the investors buying the shares, who expect to see some immediate appreciation in their investment.
Investment banks usually try to price a deal so that the opening premium is about 15%. Of course, many hot Internet IPOs have risen much more than that on their first day.
If interest in an IPO appears to be flagging, it’s common for the number of shares in the offering or their price to be cut from the expected ranges included in a company’s earlier registration statements. If a deal is especially hot, the offering price or size can also be raised from initial expectations. Although it is rare, a company can postpone an offering because of insufficient demand.
Let the games begin
Once the offering price has been agreed on — and at least two days after potential investors receive the final prospectus — an IPO is declared effective. This is usually done after a market closes, with trading in the new stock starting the next day as the lead underwriter works to firm up its book of buy orders.
The lead underwriter is primarily responsible for ensuring smooth trading in a company’s stock during those first few crucial days. The underwriter is legally allowed to support the price of a newly issued stock by buying shares in the market or selling them short (which means selling shares it doesn’t have in its account). It can also impose penalty bids on brokers to discourage flipping, which is selling shares in an IPO soon after the stock starts trading. This ability to control the price of an IPO somewhat is one reason investors feel it’s such a negative when a stock quickly falls below its offering price.
An IPO is not declared final until about seven days after the company’s market debut. On rare occasions, an IPO can be canceled even after a stock starts trading. In such cases, all trading is negated and any money collected from investors is returned.