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The Layman's Guide to Going Public: |
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Common Terms in the IPO Market The First Part in a Four-Part Series To get started, let's address some common terms used in the IPO market. Initial public offering (IPO) -- The first time a company sells stock to the public. An IPO is a type of a primary offering, which occurs whenever a company sells new stock, and differs from a secondary offering (which is the public sale of previously issued securities, usually held by insiders). American Depository Receipts (ADRs) -- These are offered by non-U.S. companies wishing to list on a U.S. exchange. They are called "receipts" because they represent a certain number of a company's regular shares. Prospectus -- The document included in a company's S-1 registration statement, which explains all aspects of a company's business, including financial results, growth strategy, and risk factors. The preliminary prospectus is also called a Red Herring because of the red ink used on the front page, which indicates that some information -- such as the price and share amounts -- is subject to change. Aftermarket performance -- Used to describe how the stock of a newly public company has performed with the offering price as the typical benchmark. Book -- A list of all buy and sell orders put together by the lead underwriter. Break issue -- Term used to describe when an newly issued stock falls below its offering price. Flipping -- When an investor buys an IPO at the offering price and then sells the stock soon after it starts trading on the open market. Greatly discouraged by underwriters, especially if done by individual investors. Greenshoe -- Part of the underwriting agreement which allows the underwriters to buy more shares -- typically 15% -- of an IPO. Usually done if a deal is extremely popular or was overbooked by the underwriters. Also called the overallotment option. Gross spread -- The difference between an IPO's offering price and the price the members of the syndicate pay for the shares. Usually represents a discount of 7% to 8%, about half of which goes to the broker who sells the shares. Also called the underwriting discount. Indications of interest -- Gathered by a lead underwriter from its investor clients before an IPO is priced to gauge demand for the deal. Used to determine offering price. Lead underwriter -- The investment bank in charge of setting the offering price of an IPO and allocating shares to other members of the syndicate. Also called lead manager. Lock-up period -- The time period after an IPO when insiders at the newly public company are restricted by the lead underwriter from selling their shares. Usually lasts 180 days. Offering price -- The price that investors allocated shares in an IPO must pay. Not the same as the opening price, which is the first trade price of a new stock in the open market. Opening price -- The price at which a new stock starts trading. Also called the first trade price. Underwriters hope that the opening price is above the offering price, giving investors in the IPO a premium. Oversubscribed -- Defines a deal in which investors apply for more shares than are available. Usually a sign that an IPO is a hot deal and will open at a substantial premium. Penalty bid -- A fee charged to brokers by the lead underwriter for having to take back shares already sold. Meant to discourage flipping. Premium -- The difference between the offering price and opening price. Also called an IPO's pop. Proxy -- An authorization (in writing) by a shareholder for another person to represent him/her at a shareholders' meeting and exercise voting rights. Quiet period -- The time period in which companies in registration are forbidden by the Securities and Exchange Commission to say anything not included in their prospectus, which could be interpreted as "hyping a deal". The Layman's Guide to Going Public Selling the Deal Part Two in a Four-Part Series Once a company decides to go public, it needs to pick its IPO team, consisting of the lead investment bank, an accounting firm, 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 registers with the Securities and Exchange Commission (SEC), all the members of the IPO team plan a timetable for going public and assign specific duties to each member. The most important and time-consuming task facing the IPO team is the development of the prospectus, a business document that essentially serves as a brochure for the company. Since the SEC imposes a “quiet period” on a company once it files for an IPO, (generally lasting until 25 days after the company’s stock has started trading), the prospectus will have to do most of the talking and selling for the management team. The prospectus includes all financial data on the company for the past five years, information on the management team, and a description of the company’s target market, competitors, and growth strategy. The prospectus also includes other important information, such as legal disclaimers, SEC-mandated disclosures, and proposed details of the IPO. The underwriting team goes to great lengths to make sure all information in the prospectus is accurate and complete. Once the preliminary prospectus is printed and filed with the SEC, the company has to wait as the SEC, the NASD, and other relevant state securities organizations review the document for any omissions or errors. If any agency finds any problems with the prospectus, the company and the underwriting team must address such problems with amended filings. While the prospectus is under agency review, the lead underwriter assembles a “syndicate” of other investment banks that will help sell the deal. Each bank in the syndicate will get a certain amount of shares in the IPO to sell to clients. Syndicates usually include investment banks with complementary client bases, such as those based in certain regions of the country. The Layman's Guide to Going Public The Roadshow Part Three in a Four-Part Series
The next step in the IPO process is the grueling, whirlwind multi-city world tour-also known as the "roadshow." The roadshow usually lasts a week or two, with company management traveling to a new city every day to meet with prospective investors and show off its business plan.
The typical U.S. stops on the roadshow include New York, San Francisco, Boston, Chicago, Denver, and Los Angeles. If appropriate, international destinations like London may also be included.
How a company's management team performs on the roadshow is perhaps the most crucial factor in determining the success of the IPO. Companies need to impress institutional investors so that at least a few of them are willing to purchase significant stakes.
The roadshow is also the most blatant example of how unfair the IPO market can be for the average investor. Only institutional investors and big money players are invited to attend the roadshow meetings, where statements regarding a company's business prospects-discussed only minimally in a prospectus-are talked about quite openly. Such disclosures, according to the SEC, are legal, as long as they are expressed orally.
Once the roadshow ends and the final prospectus is printed and distributed to investors, company management meets with its 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.
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 expressed in the company's earlier registration statements. If a deal is especially hot, the offering price or size can also be raised from initial expectations. Somewhat more rarely, a company may postpone an offering due to insufficient demand. Let the games begin
Once the offering price has been agreed to -- 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 (meaning shares it doesn't have in its account). It can also impose penalty bids on brokers to discourage flipping, which is when investors sell shares in an IPO soon after the stock starts trading. This ability to control somewhat the price of an IPO is one reason why 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
Source: E*OFFERING and Hoovers Online
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