A Look At The IPO Process

An initial public offering or IPO is a mechanism for companies to make available for the first time shares of their stock. Its purpose is to either raise capital for a new company or to fulfill a desire by an existing company to make their shares available to the public. Whether it is a new or existing company, the IPO process follows a fairly straight forward path with precise steps along the way.

The first thing a company must do before issuing stock is file a registration with the Securities and Exchange Commission (SEC.) Since the SEC has the power of nullifying any attempt to go public, a companys statement must be thoroughly accurate. Data concerning the financial health of the company must be entirely truthful. Due diligence should be the order of the day. Putting a company out onto the IPO Market is serious business. Every step in the IPO Process must be done carefully.

After (and sometimes before) the registration statement is finished, companies engage the services of one or more investment bankers. The role of any investment banker(s) is mostly twofold. First, it is to distribute the companys prospectus to prospective buyers of the stock. The prospectus is a legal document that details among other things the companys market, financial statements, executive biographies, and a projected price range for the stock. It is sometimes referred to as a red herring. It is so named because on the cover of the prospectus, and in red ink, is a notice from the SEC that the companys stock may not be bought or sold until the registration statement has been approved.

The second function of an investment banker or underwriter is to buy the companys shares and resell them to the public. Usually a road show, is launched, during which the investment banker and company executives engage potential investors to explain company strategy and promote the stock.

In selling the shares to the underwriter, rather than directly in the marketplace (i. E. The New York Stock Exchange, ) a company does not assume market risk, it does not bear excessive promotion expense, and most importantly, it acquires its money up front. Of course, by mitigating risk and selling their stock at a fixed price to an underwriter, companies sacrifice the possibility of a higher per share price that might otherwise be generated at an exchange.

The above does not happen until SEC approval has been granted. After approval and usually a day or so before the actual public offering, the company and the investment banker agree on a share price and the number of shares to be sold. The offering is complete when the company receives the money and delivers the shares to the underwriter.

Underwriters do extensive research before committing to buy a companiess securities. They take on a calculated risk, essentially betting that the price per share they pay out to a company will be less than what the market is willing to pay for it. Opportunities for huge profits and losses exist in this environment.

Needless to say the IPO process, though fraught with risk for the investment banker, represents an exciting and hugely profitable opportunity. Just imagine if you were in a position to buy low the stock of the next high tech giant.