Initial Public Offering (IPO) Process Steps

An IPO, or Initial Public Offering, is the process where a private company offers stock to the public for the first time, aiming to raise capital. Through this process, colloquially known as floating, or going public, a privately held company is transformed into a public company.

After the IPO, shares are traded freely in the open market at what is known as the free float. Stock exchanges stipulate a minimum free float both in absolute terms (the total value as determined by the share price multiplied by the number of shares sold to the public) and as a proportion of the total share capital (i.e., the number of shares sold to the public divided by the total shares outstanding).

While an IPO timeline can stretch across years, many professionals recommend operating as a public company for one to two years before actually going public.

Here's a detailed look at the steps involved in the IPO process:

Step 1: Hire Underwriters

Traditionally, the IPO process is initiated by a private company hiring several investment banks-often referred to as “underwriters”-to advise on the transaction and ensure the maximum amount of capital is raised, with the minimal amount of issues encountered (e.g.

The first step in the IPO process is for the issuing company to choose an investment bank to advise the company on its IPO and to provide underwriting services. Underwriting is the process through which an investment bank (the underwriter) acts as a broker between the issuing company and the investing public to help the issuing company sell its initial set of shares.

There are different types of underwriting agreements:

• Firm Commitment: Under such an agreement, the underwriter purchases the whole offer and resells the shares to the investing public. The firm commitment underwriting arrangement guarantees the issuing company that a particular sum of money will be raised.
• Best Efforts Agreement: Under such an agreement, the underwriter does not guarantee the amount that they will raise for the issuing company.
• Syndicate of Underwriters: Public offerings can be managed by one underwriter (sole managed) or by multiple managers. When there are multiple managers, one investment bank is selected as the lead or book-running manager. Under such an agreement, the lead investment bank forms a syndicate of underwriters by forming strategic alliances with other banks, each of which then sells a part of the IPO.

The letter of intent remains in effect until the pricing of the securities, after which the Underwriting Agreement is executed.

Step 2: Red Herring Prospectus + Roadshows

Once the company prepares to “go public”, the investment banking advisors will market the company to institutional investors via “roadshows” to first secure demand from those investors with substantial sums of capital.

The roadshow comprises a series of presentations given by senior management alongside their team of advisors to potential institutional investors to gauge their initial interest and figure out how to convince them to participate, i.e. “book building”.

Before the roadshow, the advisors also prepare a preliminary prospectus, also known as the “red herring prospectus”, which contains information on the company (e.g.

In the cooling-off period, the underwriter creates an initial prospectus which consists of the details of the issuing company, save the effective date and offer price. Once the red herring document has been created, the issuing company and the underwriters market the shares to public investors.

Step 3: Submit S-1 Filing

The pricing of the offering is arguably the most important decision because the offering price is perhaps the most influential determinant of investor demand.

The terms surrounding the IPO, such as the offering price and listing date are largely predicated on the interest level of institutional investors, as their participation is crucial to the underwriting process.

The SEC requires that the issuing company and its underwriters file a registration statement after the details of the issue have been agreed upon. The registration statement ensures that investors have adequate and reliable information about the securities.

The registration statement consists of information regarding the IPO, the financial statements of the company, the background of the management, insider holdings, any legal problems faced by the company, and the ticker symbol to be used by the issuing company once listed on the stock exchange.

The first part of the S-1 contains the legally required information detailing the sale of the securities. The information covered tends to be an overview of the company’s history, its long-term vision (i.e.

The company’s operating segments must be identified and described in detail. The methodology used to arrive at the stated offering price is explained in-depth here, e.g.

Since dilution is a significant risk to investors, the current capitalization (i.e.

A biography section with details on the background and qualifications of each director and executive officer (e.g.

Step 4: Obtain Formal SEC Approval

The formal approval and sign-off on the S-1 filing from the SEC is mandatory before the company’s shares can be distributed into the open markets.

After the IPO is approved by the SEC, the effective date is decided. On the day before the effective date, the issuing company and the underwriter decide the offer price (i.e., the price at which the shares will be sold by the issuing company) and the precise number of shares to be sold.

Deciding the offer price is important because it is the price at which the issuing company raises capital for itself.

Step 5: IPO Share Issuance

Once shares are officially issued, the company’s IPO is technically complete, and it is now recognized as a publicly traded company. But the underwriters must continue with their efforts to ensure all the stock issuances are sold and to stabilize the price, if necessary, i.e.

After the issue has been brought to the market, the underwriter has to provide analyst recommendations, after-market stabilization, and create a market for the stock issued. The underwriter carries out after-market stabilization in the event of order imbalances by purchasing shares at the offering price or below it.

The final stage of the IPO process, the transition to market competition, starts 25 days after the initial public offering, once the “quiet period” mandated by the SEC ends. During this period, investors transition from relying on the mandated disclosures and prospectus to relying on the market forces for information regarding their shares.

After the 25-day period lapses, underwriters can provide estimates regarding the earning and valuation of the issuing company. Thus, the underwriter assumes the roles of advisor and evaluator once the issue has been made.

Key Roles in the IPO Process

Many stakeholders are involved in the IPO process, so it’s critical that the right team is in place for a smooth process. What are they responsible for?

• CFO: Ensures the financial statements are accurate and accessible.
• Legal counsel: Reviews securities laws and guides the organization throughout the IPO process. As the general counsel, you’ll be responsible for risk management and governance matters throughout the IPO process. As the law firm to a company preparing for an IPO, you’ll be responsible for aiding and guiding the organization throughout the IPO process.
• Underwriter: Responsible for comparing past records and performance, preparing documents, filing statements, and managing issuance during the IPO process.
• Filing vendors: Responsible for making sure the registration statement is accurate and filed correctly.

IPO Pricing and Allocation

Deciding the offer price is important because it is the price at which the issuing company raises capital for itself. IPOs are often underpriced to ensure that the issue is fully subscribed/ oversubscribed by the public investors, even if it results in the issuing company not receiving the full value of its shares.

If an IPO is underpriced, the investors of the IPO expect a rise in the price of the shares on the offer day. It increases the demand for the issue. Furthermore, underpricing compensates investors for the risk that they take by investing in the IPO.

Gross spread/underwriting discount: Gross spread is arrived at by subtracting the price at which the underwriter purchases the issue from the price at which they sell the issue. Typically, the gross spread is fixed at 7% of the proceeds. The gross spread is used to pay a fee to the underwriter. If there is a syndicate of underwriters, the lead underwriter is paid 20% of the gross spread. 60% of the remaining spread, called “selling concession”, is split between the syndicate underwriters in proportion to the number of issues sold by the underwriter.

Success Metrics for an IPO

The IPO is considered to be successful if the company’s market capitalization is equal to or greater than the market capitalization of industry competitors within 30 days of the initial public offering. The IPO is considered to be successful if the difference between the offering price and the market capitalization of the issuing company 30 days after the IPO is less than 20%.

Dutch Auction

A Dutch auction allows shares of an initial public offering to be allocated based only on price aggressiveness, with all successful bidders paying the same price per share.

One version of the Dutch auction is OpenIPO, which is based on an auction system designed by economist William Vickrey. This auction method ranks bids from highest to lowest, then accepts the highest bids that allow all shares to be sold, with all winning bidders paying the same price. It is similar to the model used to auction Treasury bills, notes, and bonds since the 1990s.

Benefits of an IPO

Undergoing an IPO (i.e.

• Liquidity Event: From the perspective of management and existing pre-IPO investors, the IPO can be a liquidity event. While the IPO is an opportunity for management to “take some chips off the table”, venture firms and growth equity investors often must liquidate all of their positions, irrespective of their long-term thesis on the company’s prospects.
• Improved Branding: As a side benefit, the company’s branding tends to benefit substantially post-IPO, especially from investors interested in potentially owning shares, which indirectly expands the company’s name recognition and makes it easier to attract (and retain) more qualified employees.
• Lower Cost of Capital: By becoming a publicly-traded company, a company can potentially benefit from having access to cheaper forms of capital, e.g.

Risks of an IPO

• Less Control: The primary risk to management is the company-by virtue of becoming a public company-is no longer under their complete ownership and control.
• Disclosure Requirements: The disclosure requirements as part of going public is meant to provide full transparency of the internal workings of the company, which opens management up to public scrutiny by investors. In addition, the company’s closest competitors can access their filings such as their financials and plans to achieve future growth.
• Near-Term Oriented: The quarterly filings (10-Q) place more pressure on the management team to meet short-term earnings targets (i.e. earnings per share) and other performance metrics tied to revenue or EBITDA, for instance.
• Costly Process: The process of going public can be a lengthy process, where the company incurs significant costs, such as advisory fees paid to the investment banks, legal fees paid to lawyers, and other fees paid to third parties like auditors and consultants.
• Operational Disruption: The disruption to the company’s day-to-day operations is yet another factor that must be taken into account. The IPO process can meet unexpected, time-consuming hurdles that can extend the time from announcement to becoming a public company.
• Reporting Requirements: The reporting requirements associated with becoming a public company mean more time, effort, and capital must be spent on ensuring compliance with the strict rules established by the SEC.

The IPO Process is essential for a healthy financial market.

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