Steps to an Initial Public Offering (IPO)

An initial public offering is described as the primary sale of stock by a private corporation to the public. It is basically the first time that a formerly private organization decides to trade its shares to “the general public”. There are a number of steps involved that are described below:

Step 1: Choose an investment bank

Initially, the issuing organization has to pick out an investment bank so that it can advise the company on its IPO. Furthermore, it also offers underwriting services. The factor involved in selecting the banks are; quality of research, prior relationship with the bank, reputation and industry expertise.  

Step 2: Understanding costs

Going public involves four major types of costs. There are numerous Pre IPO Direct Costs such as the underwriter. Appointing an underwriter will usually cost between 5-7% of the offering. Secondly, there is cost of the auditor who is responsible for issuing comfort letters to the underwriters, review the registration statement and other documents in the offering, and audit the financial statements. These auditors cost approximately $0.5 – $1.2 million. Other costs include legal, IPO consultant, road show listing fees and registration.

Another kind of costs is Pre-IPO Indirect Costs. These indirect costs vary according to every company’s unique needs. Restructuring costs is the amount needed to restructure a business. These costs are made up of legal, valuation, human resource, audit, information technology, and financial advisory fees. Similarly, there are costs related to Valuation Services and Reports, and Articles of Incorporation that fall in this category.

The third kind of costs can be categorized as Post-IPO Recurring Costs. One of the major chunks of costs incurred in this group comes from new a staffing expense; which includes hiring, retaining and training costs. Advisor Fees (Tax, Accounting, and Consulting) is another imperative cost because maintaining records that are under constant scrutiny is not easy.

Lastly, there are certain costs which are only incurred one time Post-IPO. It is estimated that organizations spend approximately $1 million on one-time costs, post-IPO. It consists of New Financial Reporting System and Implementing New Controls. Although some of the costs might incur prior to the IPO but it may need to fully integrate with the system.

Likewise, New Board of Directors also comes with a cost. This is in case if you don’t already have BOD’s or there is gigantic restructuring. Moreover, if you are aiming to include a new compensation plan then you will surely be finalizing it at this stage and will cost the company.

Step 3: Due thoroughness and regulatory filings

Underwriting is a procedure in which the investment bank plays the role of a broker amid the company that has issued the shares and the general public to facilitate the issuing company in selling its preliminary shares. There are numerous arrangements accessible to the issuing company such as:

  • Firm Commitment: In this agreement, the bank buys the entire offer and resells it to the public.
  • Best Efforts Agreement: Under this agreement, the underwriter only trades the securities on the behalf of the corporation.

Moreover, there are a few documents that an underwriter must draft like an engagement letter. This includes the reimbursement clause and gross spread. Other documents incorporate registration statement, letter of intent, underwriting agreement, and lastly red herring document.

 Step 4: Pricing

When the IPO is accepted through the SEC, the effective day will be determined.  On the day prior to the effective date, the issuing organization and the bank settles on the offer price that is the price at which the shares are to be sold by the issuing corporation and the exact number of shares that will be sold. Determining the price of the shares is essential because this is how a company raises capital. Nevertheless, after the stock begins to trade on the secondary market, the money is raised by the company, not the underwriter. The subsequent aspects impact the share price:

  • the failure or success of the road shows (as documented in the order books)
  • the company’s objective
  • state of the market economy

Step 5: Stabilization

Subsequent to the issue being brought to the market, the investment bank aka underwriter must offer after-market stabilization, analyst recommendations, and generate a market for the stock issued. The underwriter is responsible for carrying after-market stabilization in the incident that there are order imbalances by buying shares at the offering price or less than that.

Stabilization activities cannot be carried out for too long but the underwriter during this period has the freedom to sell and impact the price of the share as there are no prohibitions against price manipulation.

Step 6: Shift to Market Competition

The last stage of the IPO procedure is the shift to market competition, which begins 25 days following the initial public offering, after the “quiet period” authorized by the SEC finishes. Throughout this phase, investors move from depending on the permitted disclosures and prospectus to depending on the market factors for data concerning the shares. Subsequent to this time period, underwriters are able to give estimates of the earning and valuation of the company.

In short, no two IPO will ever cost the same. The main direct cost element is the “underwriting discount”. This is a variable cost that is frequently set as 7% of gross proceeds (for instance if the company raises $100 million, the gross spread will be $7 million). The other big costs include professional fees salaried to the company’s external auditors and SEC counsel.  This could range anywhere from $2-4 million contingent upon the size of the firm. The rest of the fees are not so significant and are associated with above costs, such as stock exchange listing fees, press releases, printer fees, travel costs, stock transfer agents etc.  All of this can approximately add up to be another $500K to $1 million.

Type Cost
Underwriting cost 7% of gross proceeds ($7 million if the company raises $100 million)
External auditors and SEC counsel $2-4 million
Legal Counsel $3000-$10,000
Miscellaneous Costs (Printer fees, travel costs, stock transfer costs etc) $500k – $1 million

 

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