Initial Public Offerings




What is an IPO?
An initial public offering (IPO) is the process of a company first selling its shares to the public. These shares are initially issued in the primary market at an offering price determined by the lead underwriter.
The primary market consists of a syndicate of investment banks and broker dealers that the lead underwriter assembles and that allocate shares to institutional and individual investors. Being allocated shares at the offering price is referred to as participating in the IPO. Participation in the IPO happens before the security is first traded on any of the stock markets.


Why and how does a company go public?
A company goes public to raise capital for financing business plans, capital expenditures, and growth opportunities. When a company intends to go public:
The company picks a lead underwriter to help with the securities registration process and the distribution of the shares.
The company must develop a preliminary prospectus that includes information on the management team, the company’s target market, competitors, all financial data for the company, and the expected price range and number of shares to be issued.
The lead underwriter files a registration statement on behalf of the issuing company with the Securities and Exchange Commission (SEC). The company must typically wait a minimum of 20 days for the SEC to review the registration statement.
The SEC reviews the statement and preliminary prospectus to determine if the issuer meets legal and regulatory requirements. However, the SEC neither approves nor disapproves the issue itself, it only clears the issue for sale.
During the SEC review process, the lead underwriter assembles a group of other investment banks and broker dealers to become members of the underwriting syndicate.
After the registration statement is filed and preliminary prospectuses are distributed, the underwriting syndicate and selling group members act as a distribution channel by recording indications of interest in the IPO on the part of institutional and individual investors.
After the SEC declares the registration statement effective and the offering price has been determined, the selling group members are able to accept the confirmed indications of interest and begin the share allocation process.


What is a variable interest entity?
A variable interest entity (VIE) is a company in which control is established and enforced through a series of contractual arrangements, rather than through equity ownership. In some countries with restrictions on foreign direct investment, companies may use VIEs as investment vehicles to offer shares to foreigners. However, because ownership of a variable interest entity does not represent true ownership of the company’s assets, investing in VIEs carries additional risks. These include:
Lack of true asset ownership. VIEs do not represent ownership in the company as stock does. In the event of a bankruptcy, owners of a VIE may not be entitled to the assets of the underlying firm.
Corporate governance. Because shares in a variable interest entity do not generally entail true voting rights, owners of VIE vehicles may have limited influence over issues of corporate governance.
Legal and regulatory. Historically, VIE structures have not been well-tested in court. In the future, there is the risk that foreign courts, regulators, or governments may invalidate them.
When will the offering be priced for sale?
The lead underwriter sets the offering price on a new issue typically on the evening of the day when the Securities and Exchange Commission (SEC) declares the registration statement effective.
Once the registration is declared effective and the offering price has been set, confirmations of indications of interest can begin.
indications of interest can begin.


How is the offering price determined?
The price is normally based on such factors as the company’s financials, products and services, income stream, as well as the demand for the shares and current market conditions.
The underwriter must determine a fair offering price which takes into consideration the need for the company to raise capital while offering the new issue at a price which represents a fair value of the shares.
The offering price and/or number of shares issued could be raised or lowered from what is described in the preliminary prospectus. Additionally, the offering can be delayed or postponed based on unfavorable market conditions.


When do the shares begin trading?
Typically, the day following pricing is the first day that the new security will trade on the secondary market (i.e., NYSE, Nasdaq or AMEX).