Initial Public Offerings
Initial Public Offerings, or IPOs, are securities transactions in which shares of a company’s stock are offered for sale to the public for the first time. This marks the company’s change from a private company to a publicly traded corporation. IPOs allow companies to raise capital and early investors to realize the return on their investment. In recent years, technology companies have received extensive coverage for holding successful IPOs.
Whether to Go Public
When a company wants to hold an IPO, the first step is completing an internal analysis of whether it is ready and the advantages outweigh the risks. IPOs can be hugely profitable for the right companies, but they are not without risks, including a failure to raise the expected capital and ceding control to shareholders and a board of directors.
Once the company has decided to go public, the first step for most companies is to find an investment bank to underwrite the sale. The underwriting bank actually buys the shares and then sells them to the public, rather than the company selling the shares itself. The bank takes a percentage of the sale as a fee.
The SEC Filing Requirement
Choosing an underwriting bank is important because the bank will help the company file the paperwork necessary to offer its shares for public sale. Most companies file Form S-1, which satisfies the Securities Act of 1933’s requirement that securities for sale to the public are registered with the Securities and Exchange Commission. The S-1 form asks for information regarding the financial state of the company, what the newly raised capital will be used for, the company’s business model, the pricing methodology, and other important information potential investors will use in deciding whether to buy the stock.
After passage of the Jumpstart Our Business Startups Act (JOBS Act), which relaxed some requirements imposed by federal securities law, companies can choose to file the S-1 form privately with the SEC. The information is kept confidential until the agency determines that the filing requirements have been met, and the company makes a final decision about going public. Then, the information is made public.
Some companies may be exempt from the SEC filing requirement. One major category of exempt businesses includes those that operate mostly within one state and offer shares only to residents of that state. This is called the intrastate offering exemption. However, even if it is exempted from the registration requirement, the company must still comply with the state’s blue sky laws.
The bank will work with the company to determine the share price and how much of the company to sell, typically between 10 and 25 percent, although it can vary. To determine the price, the bank looks at many factors, including the cash flow of the company, its competitors’ share prices, market conditions, and expected demand.
Twenty-one days after the S-1 form is filed—a time known as the “cooling off period”—the company and its bank can meet with investors. It is during this period that the bank announces the terms of the IPO and begins taking orders from prospective investors. These orders are not guaranteed. Which investors get how many shares is determined by the investment bank and is revealed at the end of this series of meetings.
Active Trading Begins
After the bank decides the allocation of the initial shares, the company can begin trading on the selected securities exchange. The price at which the initial investors bought the stock is not necessarily the price at which shares will begin trading. That depends on demand.
For 25 days after the IPO there is another cool down period, during which the investment bank that served as the underwriter cannot publish information about the company. For some big IPOs, this period is 40 days. Generally, there is also a waiting period during which insiders—such as the founders of the company and some early investors—must wait before selling stock. It is called the “lockup,” and it can last from a few weeks up to a year.