A previous post discussed the pros and cons of going public, which can be found here:
This post provides a simplified overview of the IPO process, which can be long and complicated. This is mainly based on my experience an investment banker during the late 1990s and early 2000s.
To read more, please click “Read More” below.
Parties to the IPO Process
There are many parties involved in an IPO:
- The Company. An IPO is all about the company. The company’s senior management will be heavily involved in the IPO process.
- Investment Banks. A group of investment banks, called underwriters, manage the IPO process. The underwriters lead the preparation of the offering documents, conduct due diligence on the company and its management team (to make sure there are no skeletons in the closet), prepare investor marketing materials, and sell the company’s stock in the IPO.
- SEC. The Securities and Exchange Commission, or SEC (www.sec.gov) regulates the IPO process. The SEC must review, comment on and approve the documents before the IPO can be held.
- Attorneys. The company’s attorneys draft the manifold documents and manage the SEC filings.
- Accountants. The company’s accountants prepare the financial statements that appear in the offering documents and the financial disclosures.
- Stock Exchange. The company must list its shares with a stock exchange (NYSE or NASDAQ). Once the IPO is held, the company’s stock will be traded on this exchange after the IPO occurs.
- Pre-IPO Investors. The company’s pre-IPO investors helped the company grow from when it was a start-up to being an IPO ready company. These investors can include the founders, friends and family, angel investors, venture capital funds, private equity funds, and strategic investors. Many of these investors will want to sell their shares in the IPO or as soon as the IPO lockup restrictions (see my post on IPO lockups for more) expire.
- IPO Investors. These are mainly institutional investors, such as mutual funds, that buy the company’s stock in the IPO. Some shares are also sold to retail investors, but the vast majority of the shares are sold to institutional investors.
The IPO Process
IPO Step 1: IPO Preparation
The first steps towards an IPO occur a long time before the process really starts, often two or more years before the IPO. First, companies planning to go public must have a public company-caliber management team in place, including a seasoned Chief Executive Officer and Chief Financial Officer. In addition, the company must have appropriate accounting and financial controls and processes in place and functioning smoothly. Further, the company needs to have an investor relations team in place, which will coordinate with the market after the IPO occurs. The company also needs to have audited financial information for several years prior to going public.
IPO Step 2: Underwriter Selection
Once the company feels that it has the management team, processes and controls and other items in place for the IPO, the next step is to select a group of investment banks, known as underwriters, to manage the IPO. This interview process is known in the industry as a “bake-off.” The company will interview several investment banks to determine which one will lead the IPO process, and which others will be part of the underwriting group. Investment banks that are commonly lead underwriters include:
- JP Morgan
- Morgan Stanley
- Goldman Sacks
- Credit Suisse
- RBC Capital Markets
- Bank of America Merrill Lynch
- Deutsche Bank
- Wells Fargo
- Allen & Co.
IPO Step 3: The Kick-off Meeting
Once the underwriting group is selected, a “kickoff meeting” or “organizational meeting” is held. In attendance at this meeting are the company’s senior management, the underwriters and the lawyers. Discussed at the meeting include topics such as the IPO process, the timeline for the process, roles and responsibilities, and legal and accounting matters.
IPO Step 4. Drafting Sessions and Filing the Registration Statement
After the kickoff meeting, a series of meetings are held to draft the IPO materials which will be filed with the SEC, known as the “S-1 registration statement,” the “S-1” or the “registration statement.” For most large companies, once filed, these registration statements are public documents which can be found on the SEC’s EDGAR database (https://www.sec.gov/edgar/searchedgar/companysearch.html). However certain smaller companies can file the registration statement confidentially with the SEC (as a result of the Jumpstart Our Business Startups Act of 2012).
IPO Step 5. SEC Review, Road Show Prep, Exchange Applications
The SEC reviews the documents and provides comments. After the company receives the SEC’s comments, the registration statement is amended and filed with the SEC. This process repeats until the SEC is satisfied.
While the SEC is reviewing the documents, the company prepares for its road show, which is a series of marketing meetings with institutional investors who may buy shares in the IPO. The road show preparation includes creating a road show PowerPoint presentation, a video presentation (which is offered online to institutional and high net worth individual investors, underwriter sales force IPO summary (used by the underwriters’ sales forces to generate interest in the company’s stock once it is trading on an exchange), and practicing the presentations with company’s management.
The company will also decide which exchange (the NYSE or Nasdaq) the company’s shares will trade on once the IPO is held. Each exchange has certain criteria which must be met to list on the exchange, such as revenues, assets, etc. The company files an application with the exchange to have its shares listed on the exchange.
IPO Step 6: The Road Show
Once the SEC has provided its comments and the company’s registration statements is complete (other than pricing information), the investment banks have completed their due diligence and received their internal committee approvals, the company will go on a road show. These road shows take about two weeks, and the lead investment bank takes the company’s management around the country (and select foreign cities such as London) to meet with institutional investors to generate interest for the IPO.
During this process, a group within the lead investment bank, called the capital markets group, will call the institutional investors after their meetings to gauge their interest in buying the company’s stock in the IPO. The capital markets group will keep a running tab of potential investors, how many shares they are willing to purchase in the IPO, and what price per share they are willing to pay. Through this process, the capital markets group builds an “order book”, and using this information, the investment bank and the company can decide how many shares to issue at what price.
IPO Step 7: Pricing the IPO
When the company, the investment banks and the institutional investors have all agreed on a price and total number of shares, and the SEC gives its the IPO the go-ahead, the IPO is priced and sold. The mechanics are complicated, but effectively an IPO is a three-step process: first, the shares are sold to the underwriters; second, the underwriters instantly sell the shares to the institutional investors who put in orders during the road show and a select group of other investors; and third, the shares start trading on the exchange. Because of this complicated process, the IPO price (which is the price the shares are sold to the institutional investors) is different from the price of the first trade on an exchange. For example, Dropbox, Inc. priced its IPO (and sold shares to institutional investors) at $21.00 per share on March 21, 2018. Dropbox shares started trading on March 23, 2018 and the opening trade was $29.00.
IPO Step 8: Trading
As mentioned above, the IPO is typically priced the night before it starts trading on an exchange. The pricing builds in an “IPO discount” of around 15% as an incentive for the institutional investors to buy this risky stock. Since everyone knows about this built-in discount, it is expected that the stock will start trading at a premium to the IPO price. This increase from the IPO price to the initial trade is called the “IPO pop” or “price pop.” Using the Dropbox example, it priced its IPO at $21.00 and the first trade was at $29.00 representing a 38% jump in price from pricing to the initial trade. Not a bad result for the institutional investors (and the lucky few retail investors who purchased at the IPO price.
At this point, the company is now a publicly traded company.
After the company is public, there are more things that happen. The first one is price stabilization. This occurs if the stock price dips below the IPO price, which is a sign of a struggling IPO. See my post “Understanding the Over-Allotment Option, or Green Shoe, in an IPO” for a discussion of this process. Another is the issuance of equity research reports by the underwriters. This is an important part of the IPO process as the research helps keep the company and its stock in the investing public’s eye, and favorable equity research reports drive trading in the stock (and usually an increase in the stock’s price).
So there it is. A brief summary of the IPO process. Note that a number of parts of the process, as well as other concepts and terms have been simplified, abbreviated or omitted for clarity and so the post isn’t too long.
Other posts on IPOs include:
- IPO 101: Pros and Cons of Going Public
- What is a Successful IPO? – Updated
- IPO 101: IPO Lockup Periods
- Understanding the Over-Allotment Option, or Green Shoe, in an IPO
- Thoughts On IPOs With Multi-Class Share Structures
- Warning Signs for IPOs
- Facebook's IPO Deconstructed: What Happened?
There are many more. To find more, please click on IPO in Categories or search for IPO in the site search bar.
© 2018 Allen J. Latta. All rights reserved.