2018 and 2019 have been hot years for the IPO market. Investors’ appetite for the new and fast-growing companies has been voracious, and start-ups, along with their early investors have used all-time stock markets high to cash in. An Initial Public Offering is the beginning of a great journey ahead. This can be related to the IRCTC IPO that grabbed much of investors' attention and stock price jumped to 645 from 310 on the first day after getting listed.
Having said that, let's have a look into the details of what an Initial Public Offering is, the steps involved in listing of an IPO and IPO Process:
What’s an IPO?
The Initial Public Offering or the IPO process is where a private company that is owned by a small number of shareholders goes public and is listed on an exchange where it can be held by a large number of investors. An Initial Public Offering is a significant stage in the growth of many businesses as it provides them with access to the public capital market and also increases their credibility and exposure.
Let’s look at the actual IPO process itself.
Step 1: Select an investment bank to lead the underwriting process
Before coming to the procedural part, let’s try to figure out what Underwriting is. So, Underwriting is an essential yet expensive IPO process through which shares are issued and sold in an Initial Public Offering. Let’s understand this IPO process with the help of a short story:
A 6-year-old kid saw a new attractive toy in a market. So, now he wants to get that toy at any cost. But parents aren't buying it for him. So, he went to his elder sibling to take an idea about how to get that toy. His sibling advised him to save pocket money and break his existing savings or borrow a few bucks from his friends. The accumulated money will then be sufficient to buy that toy. As he borrowed money from friends, he will let them play too, despite the toy being his own. So, this is how the investment banking IPO process takes place. And to give the advices, suggestions, bankers charge fees from big corporations or business magnates to earn their livelihood.
So..essentially, what should be the selection criteria for an investment bank? What if it defaults?
This leads us to the following characteristics which I feel one should look for an investment bank:
The reputation of the Bank, Quality of its equity research, expertise and Industry experience in that sector, ability to sell the deal to investors, traders and salespeople. All the above factors should be considered as set parameters in determining the bank that will help in the IPO process.
Step 2: Due diligence and regulatory filings
After putting together a team to handle the Initial Public Offering, the business must then prepare an initial registration statement according to SEC regulations. Let’s first look at how a company agrees to be sold through its investment bank.
There are several different types of commitments-
A firm commitment is where the underwriter purchases the entire offering and sells it to the public. Therefore, the bank takes all the risk. Those are not very common.
The next way is the best efforts agreement where the underwriter does not guarantee any pricing or take any risks but does its best to sell the offering to the public. These are much more common. And at last, banks often work in syndicates where multiple underwriters work together to sell the deal across several banks.
There are a lot of documents that have to be filed during this IPO process. The first thing that happens is there's an engagement letter between the company going public and the investment bank. Then there's an underwriting agreement, a registration statement that has to be filed with the regulators. Multiple versions of the prospectus from preliminary to final have to be filed with investors.The prospectus contains important information about the Company such as valuation figures, risks and rewards of the investment. Public filing of these forms is the final step for this IPO process.
Step 3: Pricing
Investors determine the final price of the Initial Public Offering. The investment bank takes hefty initiatives to market the IPO. They are generally priced at a discounted rate to attract the public. This is to make sure that they perform well when they start trading on a public market. So on average, IPO's pop or rise in value in the first few days of trading.
Step 4: Stabilization
After the trading begins in the market, the bank starts taking measures to stabilize the price of the securities. The banks will start buying shares if there are not enough buyers. Thus, the investment bank's role in stabilizing is essential, but it can only last for a short period since the IPO process consumes substantial capital investment.
Step 5: Transition to Market competition
The Company transitions to a normal market competition environment where the quiet period mandated by the SEC is over and the company can rely on the ongoing disclosures such as news, financial results etc...to drive the performance of its shares. The investment bank can continue to work with the company as an advisor and help it try to increase to share price over time.
Example of the IPO Process
One of the most successful Initial Public Offering was that of Facebook in 2010. The prospectus stated that Facebook had 845 million users monthly, more than 2 billion likes, and comments regularly. After the IPO, Mark Zuckerberg retained 22% of ownership share and 57% of voting shares.
As a company, an IPO could be a game-changer for you due to the reasons already mentioned. Although, if you’re an investor the following information would be useful for you.
Some of the upcoming Initial Public Offerings are- Indian Renewable Energy Development Agency, HBD Finance Services, Reliance Retail.
Given the uncertainty and risk associated with investing in these unicorns as they become public companies, one should look into the pros and cons of investing in them as well as look for the comparables. Having said that- given the risk appetite and availability of money to invest—it's for you to decide and choose which IPO you think is worth investing.