What is an Initial Public Offering (IPO)
IPO stands for initial public offering. An IPO means that a privately held company offers its company shares for the first time to the public by listing the stock on the national exchange. This action allows companies to raise equity capital through new stock issuance.
Why Do Companies Goes Public?
There are many reasons a company wants to go public; one of the main motives is to raise huge capital during the company’s growth stage. Usually, during this stage, companies require fast funds to meet the demand of the growing business.
By going public, companies have one thing in mind, which is to raise funds constantly. The expansion of a business is limitless compared to being privately held. Besides that, it also strengthens the business brands and credibility.
The Pros and Cons of IPO
Some of the key pros are:
- The ability to raise equity capital
- Strengthening the brand and credibility of the company
- Possible increase in the company valuation by taking advantage of the share trades by the public
- Creating visibility and publicity
- And an exit opportunity.
Every IPO brings a set of risks such as:
- Market pressure on the share price
- Potential loss of control in the business growth and ownership
- The need to expose lengthy financial information to the public
- The cost involved to go public.
Process and Compliance of IPO
For a private company to go public, it takes six months to a year to complete. It is a lengthy process that is required by the SEC.
- To find a suitable investment bank: The purpose of the bank is to provide sound advice and other services like underwriting. Typically, an investment bank is chosen based on
- The Credibility
- Quality of services,
- Expertise in a specific industry favorable to the company
- Type of distribution the bank does.
- To perform due diligence and filings: The bank’s role as the underwriter is to act as a broker between the company and the public. Usually, the underwriting comes with a selected commitment level by the bank.
- The best commitment will be the ‘firm commitment’ whereby the bank buys the whole shares from the company and sells them to the public.
- The other type of commitment will be the ‘best efforts’ where the bank doesn’t guarantee the fund amount raised for the company but merely sell the stocks on behalf of the company. ‘All or none’ commitment requires the whole stock issuance to be sold, or the agreement will be canceled.
- The bank will share the risk of an IPO with other banks through a ‘syndicate of underwriters. Whereby the bank will ally with different banks to sell the IPO.
- The bank will then draft the engagement letter, letter of intent, underwriting agreement, registration, and red herring document.
- Pricing: The bank will submit the paperwork for SEC approval. Once approved, the bank and the company will discuss the pricing of the stock. A few factors must be considered when fixing the price, including the current economic condition and the company’s goal.
- Stabilization: Under this step, the bank will have to provide analyst recommendations followed by after-market stabilization. Then to create a market for the stocks issued.
- Market Competition Transition: Under this final step of the IPO process, the market competition will start after 25 days of the cooling period as per the SEC’s guidelines. This means the public will transition from relying on mandates and prospectus for the stock’s information to market forces after the cooling-off period.
The required form to be completed for an IPO is the SEC’s S-1 form, which can be found on the SEC website. (https://www.sec.gov/files/forms-1.pdf). SEC will determine if a company is eligible to go public by verifying the information on the form.
Is IPO a good Exit Strategy?
IPO is a good exit strategy if the IPOs are successful. Many startups prefer IPO, which can quickly raise huge equity capital for the necessary business expansion. Once the stock reaches the secondary market (generally after the cooling-off period whereby the public can sell their shares), the market forces begin to impact the value of the stock.
When there is high trading activity on the stocks, there is a possible increase in the price per share. This strengthens the value of the company and increases the public interest.
There are three approaches under the IPO exit strategy:
- Flipping: This happens when investors start liquidating or selling their shares after acquiring them. Usually, the share price is higher when it reaches the secondary market, leading to further inflated prices when the shares are in demand. The market makers, underwriters, and even the company do not encourage this approach.
- Long term investment: Under this tactic, investors who acquired shares at the lowest price would benefit from high profit if and when the shares are held longer, taking advantage of the rising share price in the long run. This is a typical scenario in large-cap growth stocks.
- Observation of the lock-in period: Usually, there will be a lock-in period for shares held by private investors. According to the SEC, private investors cannot liquidate their holdings entirely during the lock-in period (usually between three months to two years). This is to mitigate any sharp fall in the value of the stock, thus controlling the share price by moving down sharply.
How can Startup Tandem help?
IPO is the quickest and most efficient way to fund a company’s growing needs and effectively grow the business’s size. Even though the process of going public can range from six months to a year and requires adherence to complex regulations, it is worth it as the possibilities for expansion are prominent and endless. Companies who wish to use IPO as an exit strategy, especially startups, could benefit from the market forces on the valuation of the business in the long run.
Startup Tandem has licensed advisors to help you during the process. If this is an exit strategy you have been thinking of, we can help you during your assessment to determine if indeed this is the best option for your business during this economic time. Learn more on how to choose the best exit strategy here.