The key stages of an IPO
1. Selecting an underwriter
The first stage of any IPO is the company making their ambitions known (privately) to investment banks that they would like to raise capital and list on an exchange. This generally occurs several months or more before the actual IPO date. The listing company will listen to pitches from different underwriters and select the one that they deem best fit for their purposes, and that they believe will get them the best outcome.
Some factors considered are the quality of the investment banks research and marketing teams, geographical expertise, investor client base and distribution networks, industry reputation as well as any prior dealings the company may have had with particular banks.
2. Due diligence
The chosen underwriter will do a deep dive into the company’s financials, map out their risks (regulatory concerns, legal issues, operational problems), develop an extensive amount of documentation and enter into legal agreements with the company regarding the way it intends to market the IPO.
It may choose to purchase all shares in the company and take on the full risk of selling them (full commitment), it could bring in other investment banks into the fold in order to spread the risk (underwriting syndicates), or they can agree to a “best efforts” contract where the underwriter will try to sell as much of the offer as they can, but won’t agree to purchase a certain amount of the stock to guarantee an amount of capital raised.
Once the specifics of the deal between the company and underwriter are finalised, regulatory filings are prepared and sent to the relevant regulator. This part of the process is kept on the down low, as anyone working on the IPO are bound by insider trading laws. It’s privileged and confidential info at this point in time, until the relevant regulator releases the filings.
3) The IPO roadshow
This is like a travelling sales pitch, where the underwriter goes to different institutions and investors and pitches the company. They want to gauge the valuation and price of the company in the eyes of the market through this process, so that they can determine a final offer price and number of shares. It’s at this time that the underwriter builds a book of interested parties, a process known as the “book build.” A number of banks, investment funds and high net worth investors who are keen on owning the stock will be short listed at this stage and will likely receive an allocation.
4) Regulatory approval & determination of stock price
After the roadshow has ended and the regulator governing the jurisdiction where the company would like to list has approved the IPO to go ahead, the underwriters now determine (based on the book build) what the final offer price and number of shares will be. This determines the valuation of the company on the IPO date. The effective date of the IPO is also chosen, typically within a couple weeks of having initially filed.
5) The company goes public
On the effective date selected by the underwriters, the shares allocated to investors are released, and trading can now begin on the exchange where they are listed. This is where the market determines whether or not the valuation of the company by the underwriter was under or overstated.
Typically, the underwriter will price the shares such that they are slightly undervalued. This is done so that there is a decent short term appreciation in the share price for current investors. It also maintains value for them if they are bound by a lock-up period (where shares cannot be sold for X amount of time after the IPO date).
But in some cases the opposite occurs. The market doesn’t agree with the underwriter’s valuation, and the stock can be taken to the cleaners on its first few days or weeks of trading. A prime example of this was Facebook back in 2012, which was sold at around $38 but fell to as low as $26 in its first few weeks of trading. It went on a horrible run for a good 6 month period post-IPO, before becoming one of the biggest companies by market capitalization today.