Initial Public Offerings (IPOs) and Legal Requirements
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. 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.
Once the S-1 form is filed, a 20-day period known as the cooling off period follows, during which the SEC reviews the form. No sales can occur during this time, although a preliminary prospectus can be shared with potential investors, and the underwriter may solicit or receive indications of interest. These are collected to forecast demand and are not binding on either party. Eventually, the effective date will be announced, which is the first day when the shares may be sold to the public. The underwriter then will decide how to distribute shares among customers who submitted indications of interest.
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.
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. Instead, the price 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.
Banking and Finance Law Center Contents