IPO in the Last Few

IPO

In the last few years there has been a marked increase in the number of company's that have gone public or gone through the process of initiating an initial public offering or IPO.

The completion of an IPO, dramatically alters the way managers of the company approach their duties and establish their operational and financial goals (Gutterman 1994; Evans & Strenski, 1996). The purpose of this discussion is to describe the process of going public, the incentive associated with an initial public offering, the reaction to new IPO's and new trend in IPO's.

The IPO Process

According to the Securities and Exchange Commission "IPO stands for initial public offering and occurs when a company first sells its shares to the public (Initial Public Offering)." The process of going public actually involves a precise process that is governed by the United States Security and Exchange Commission. This process is as follows

Development of an IPO team- this team is inclusive of accountants, attorneys, underwriters and management (Jagannathan and Venkatesam 2001). All of these individuals are needed because the IPO process is complex and the expertise of each person is needed because the reporting must be precise to meet the requirements established by the SEC (Jagannathan and Venkatesam 2001).

Complete records of the company-in most cases the company that is going public must have available three years of financial statements that have been audited. In addition, these records must include precise accounting and revenue recognition policies (Jagannathan and Venkatesam 2001). As it relates to this step in the process "The company should formalize a monthly and quarterly close process for its accounting books. Some of the key reporting items should include: sales volume, revenues and channels, list of major customers, gross margins by product line, departmental spending, and head count (Jagannathan and Venkatesam 2001)."

In addition, the report should contain balance sheet information including assets, inventory and accounts receivable. During this part of the process, it is also important that stock ownership records be current and the company's business plan should be well written.

Establish a board of directors -- a board of directors is necessary for communication with both public and institutional investors. The board of directors should be composed of professionals in the industry and/or executives (Jagannathan and Venkatesam 2001). A board of directors bring experience and credibility to the company and its efforts to operate publicly.

Improve the public presence of the company -- This aspect of the IPO process is essential because it will bring attentions to the company and alert investors that the company is about to go public (Jagannathan and Venkatesam 2001).

It is important to draw this attention to the company prior to it becoming a public company because while the company is still private there are not as many restrictions on what can be said concerning the successes of the company. (Jagannathan and Venkatesam 2001)

The authors also insist that it may be necessary to hire a public relations firm and solidify the company's presence in trade shows, press interviews (Jagannathan and Venkatesam 2001).

Hire lawyers and Choose underwriters- because there are many legal issues that the company will face is necessary to hire a lawyer who has experience with going public. In addition the company must choose underwriters. Underwriters are needed because public offerings are performed by a group of underwriters. For this reason it is necessary to choose a lead underwriter to govern the IPO. The underwriter is responsible for introducing the company to essential institutional investors and venture capitalists (Jagannathan and Venkatesam 2001).

The article also explains that there are certain considerations that must be taken to ensure that the right underwriter is chosen. Factors to consider are "reputation, ability to distribute stock widely, experience in your industry, ability to "make" the market in your stock after you go public by maintaining liquidity in the stock, and ability to provide research about your company by providing investment analysts (Jagannathan and Venkatesam 2001)."

In addition to the factors that an underwriter should possess there are certain factors that an underwriter takes into consideration when looking for a business to represent (Jagannathan and Venkatesam 2001). These factors include a rational plan for usage of proceeds from the IPO, a constant revenue history and prospects, a high-quality management team, and stable financial position.

This is the most costly aspect of the IPO process; usually the cost associated with underwriting range from 5% to 10% of the money acquired through the public offering (Jagannathan and Venkatesam 2001). Most underwriters present either "a "best efforts commitment" to sell your stock or a "firm commitment" to buy the shares for subsequent resale in the markets (Jagannathan and Venkatesam 2001)."

Preparation of the registration statement -- The next step in the IPO process is the preparation of the registration statement. The authors explain that under the laws of the United States this statement is referred to as the S-1 contains of two principal parts (Jagannathan and Venkatesam 2001). The first part of the statement contains a structured prospectus. There are two main functions of this prospectus. The first function is to endorse the sale of stock and the second function is to detail the risks associated with purchasing the stock (Jagannathan and Venkatesam 2001). The sections within the prospectus include the introduction to the business, the risk factors, prospectus summary, a detailed business section, management discussions, financial information, how the proceeds of the IPO will be used, and capitalization structure and dilution details (Jagannathan and Venkatesam 2001).

The second part of the S-1 form includes additional filings that include company sales of securities, by-laws, articles of incorporation, and employment contracts (Jagannathan and Venkatesam 2001). An initial filing of this is made to the Securities and Exchange Commission and is referred to as a "red herring" prospectus (Jagannathan and Venkatesam 2001). The Securities and Exchange commission then reviews the prospectus which can take as much as a month to complete. The SEC will either approve or ask for additional clarifications as it relates to the information concerned in the prospectus (Jagannathan and Venkatesam 2001).

Selling the stock -- After the registration has been filed, it is now time to sell the stock. As it relates to this aspect of the process the underwriter is responsible for developing a collective of underwriting firms that also take part in the IPO (Jagannathan and Venkatesam 2001). After all members of the underwriting collective agree to participate they can begin selling to their various clients (Jagannathan and Venkatesam 2001). This is known as the quiet period that exist between the registration filing and actually going public. During this period the company is also forbidden to engage in several activities including: reporting of expected sales, extreme advertising, and new partnerships not mentioned in the prospectus (Jagannathan and Venkatesam 2001). In addition the company management is expected to be available to meet with members of the underwriting collective to assist in the sell of the stock to security analysts, portfolio managers, and key individual investors (Jagannathan and Venkatesam 2001).

Finalizing the deal -- After the SEC has approved the stock with an effective date, the selling of the stock is finalized. The final price of the stock is fixed the night prior to the effective date (Jagannathan and Venkatesam 2001). This is done by the managing underwriter and the business (Jagannathan and Venkatesam 2001). The purpose of this strategy is to capitalize on the amount of funds that can be raised under the best terms (Jagannathan and Venkatesam 2001). After the price has been established the underwriting agreement is signed by the company and filed with the SEC, allowing the IPO to go forward (Jagannathan and Venkatesam 2001). During this time in the IPO process the company selects a registrar and transfer agent to manage the stock transfer and registration services. In addition the lead underwriter is responsible for the process of gathering funds and also hands over the proceeds of the public offering (Jagannathan and Venkatesam 2001).

Trading as a public company -- The final step in the process is to begin trading as a public company. This means that the company will have new responsibilities associated with the management of a company (Jagannathan and Venkatesam 2001).

In addition, the stock price now becomes constant concern (Jagannathan and Venkatesam 2001). It is also necessary that the company manage the perception of the stakeholders which include brokers, analysts, competitors, and shareholders. All material information (new deals, revenue dips, change in prospects, management changes, and so on) need to be reported in a timely manner, such as through an SEC for 8-K filing. Strict regulations exist for trading by the insiders, who can trade only during an "open window." There are quarterly filing requirements such as the SEC Form 10-Q.

Incentive associated with an initial public offering

The primary incentive of the IPO is the ability to raise funds or capital. In many high profile cases over the last few years, companies and their founders have made a tremendous amount of money as a result of going public. Many companies go public so that they can expand and so that they can offer employees additional benefits. In addition Shepherd, et al. 2001 asserts that An initial public offering appears to offer the entrepreneurial company a number of benefits, including legitimacy with stakeholders, access to debt capital (Sutton & Benedetto, 1988), and a mechanism by which entrepreneurs can reacquire control from investors (Black & Gilson, 1998). For investors, an IPO represents an exit mechanism (Sutton & Benedetto, 1988). Sahlman (1990) documents that almost all of the returns on venture capital funds are earned on companies that go public. Bygrave and Timmons (1991, p. 159) note that "hot IPO markets are by far the most important cause of peaks in venture capital returns (Shepherd, et al. 2001)."

As it relates to IPO and the current market environment the main incentive is still raising funds to expand the company and solidify the standing of the company. The aother incentives may be dependent upon the industry that the company is a member of. For instance, many tech stocks are volatile and unless it is a well-known company such as Google, the market may not be receptive to the company and investors may choose a stock that is less risky.

How will the markets react in a new wave of IPOs given past experience?

The way that the market reacts to IPO's is highly dependent upon the industry that the company is a member of.