Understanding the World of IPOs

While the IPO market is slowly returning to normalcy, we felt that now is a perfect time to untangle some concepts that investors don’t understand about the initial public offering process. We’ve decided to help educate our audience on the IPO process. For more insight on how the world of equity syndication works, read on. Before a company could file the necessary groundwork for an IPO, shareholders must commence with a vote. If all goes according to plan, the company’s auditors and lawyers must certify that all documents are on level. After this has been completed, the IPO process can begin in earnest.

Choosing an Underwriter
After the aforementioned process has commenced; it is now time for the company to select an investment bank willing to underwrite the IPO. That investment bank (also known as lead manager) is solely responsible for promoting the stock and will facilitate the sale of the company’s IPO shares.
One of the bank’s duties is to select an underwriting team based upon criteria that includes prior working relationships and industrial specialties and distribution capabilities. The presence of an important bank like Morgan Stanley or Salomon Smith Barney can draw a significant amount of interest to a deal, with the result that banks like these can pick and choose any deals they crave. So, in effect, the company must make an alluring presentation try to sell itself to the banks.

The Quiet Period
With preliminary work and underwriter selection out the way, it’s time to file with the Securities and Exchange Commission an S-1 or SB-2. From the time a company conceptualizes the idea of coming public the quiet period begins. The quiet period exists from that point until roughly one month after the IPO is consummated. The quiet period is an integral part of the underwriting process because it produces a level playing field, as far as information is concerned. During the quiet period, the only data available is what is published in the red herring.

There have been instances when the SEC has had to step in when firms have allegedly violated that legislation. For example, we can’t forget the follies that surrounded Webvan Group, a now defunct entity. It was discovered that during the road show, unpublished data was discussed in a conference call with potential investors. When the SEC got involved, it ordered a mandatory “cooling off period.” At that point, Goldman Sachs,the firm’s lead manager, delayed the deal for a while and then restarted the IPO when the situation quieted down.

Let the Games Begin
One vital piece to the entire offering process is the road show component. The road show allows the underwriters to present their case for the company and lure potential institutions to the table. In a road show, the investment banks underwriting a deal go around the country promoting a new stock. The only people allowed to attend are high net-worth individuals and institutions that play with enormous money to invest.

Underwriters can determine how to price the IPO by the demand evidenced from the road shows. When a company files a prospective deal, it usually lists a maximum dollar amount the deal looks to raise and when the road shows begin, the deal is amended to include shares and a proposed range. At this point, the lead banker invites other banks into the selling portion of the deal. This part of the underwriting team is not guaranteed shares, but could receive an allocation if stock becomes available.
These banks are not listed on the preliminary prospectus, and when they do receive an allocation, they generally get far fewer shares than the main underwriters. Their identities are only made public in the final prospectus. In most cases, even if they don’t receive an allocation, they are listed in the prospectus with shares to be sold. If they don’t receive the shares, they get paid for services they could have rendered.

Pricing and Stock Liftoff
We are now in the final stretch of deal placement. However, before a stock can begin trading, it has to price and be granted release from the Securities and Exchange Commission and the respective exchange the stock plans to trade on.
After approval is granted from the SEC, the exchange the stock will trade on sets a time for pre-market indications to begin. Pre-market indications allow all market makers for stocks on the Nasdaq and NYSE to start taking bids shortly before the issue begins trading. This allows the market makers to get a better read on the opening price of an IPO. On the American Stock Exchange, no indications take place.—Staff Analysts