Andrew Kroger Breaks Down the IPO Process

In recent decades, “IPO” has become a bit of an investment and business buzzword. But what exactly does it mean? And why is it so exciting?

An IPO is the process of creating, marketing, and selling securities (or shares) of a privately held company to the public for the first time. IPO, therefore, stands for Initial Public Offering. The IPO process involves five key steps: choosing an underwriter, due diligence and filings, pricing, stabilization, and transition.

Andrew Kroger, a 29-year old MBA graduate and business analyst from Melbourne, Australia, breaks down the IPO process.

Benefits of Initial Public Offerings

What makes an IPO such an interesting opportunity lies in the nuances of business. Privately held companies, explains Andrew Kroger, are generally funded by venture capitalists or angel investors. Oftentimes the founder of a company, their friends, and family are also big investors. But once a privately held company reaches a valuation of $1 billion, it has the option to sell some or all of its equity to the much broader audience of the public.

This is particularly good for founders or initial investors who wish to realize their gains by selling their portion of the business. In some cases, initial investors will choose to retain their stake in the company by turning their ownership into stocks, thereby becoming key stakeholders in a publicly-traded company. For the company, being traded on the open stock market comes with certain benefits, such as increased trustworthiness in the eyes of the customers, which can increase both its customer base and sales.

Perhaps the biggest draw of an IPO is the potential for raising significant capital, which can be used to generate further growth, through the broader public rather than specific individuals. For example, some of the top IPOs in recent history including Alibaba Group, which generated $25 billion in 2014, and Softbank Group, which generated $23.5 billion in 2018. For a privately held company and its owners, these kinds of numbers are almost irresistible.

While the potential for an attractive return on investment is tempting, the IPO process can be lengthy, lasting between six months and a year. It also requires significant resources that become ongoing expenses such as management time and effort reporting key information to the Securities and Exchange Commission (SEC) as well as accounting and legal efforts. It’s important to understand the process, says Andrew Kroger, adding that even the most prepared companies don’t always achieve success in the IPO.

The IPO Process

The first step in the IPO process is choosing an underwriter. Often a big investment bank, the underwriter consults with the company interested in becoming a publicly-traded company. This body will be responsible for marketing the securities before the IPO and gauging interest within the marketplace. Eventually, this information will be used to set a price for the shares in the IPO. Choosing an underwriter is a crucial step. Some factors involved include existing relationships between the company and the underwriter/investment bank, the underwriter’s experience and reputation in the market, as well as its ability to distribute shares through a network of peers and customers.

The next step is due diligence and filings. Occasionally, says Andrew Kroger, the underwriter may offer a company a guaranteed share price on the date of the IPO by essentially purchasing the shares and subsequently selling them to their network and the public through strategic marketing. More commonly, the underwriter simply acts as a broker, marketing and selling shares on behalf of the company. In larger or more complicated sales, investment banks will share the risk by engaging their network to take on blocks of shares to sell in their respective markets, thereby distributing both the workload and the risk to its peers while still managing the overall project.

Once an agreement is in place, the underwriter is obligated to produce the filings. These documents include an engagement letter, a letter of intent outlining the underwriter’s commitment to enter an agreement with the issuing company and the issuing company’s agreement to cooperate in all due diligence efforts, the underwriting agreement itself, and a registration statement. The registration statement, explains Andrew Kroger, is the document provided to the SEC including company particulars like financial statements, management’s backgrounds, insider holdings, legal issues past and present, as well as the ticker symbol to be used on the stock exchange. The SEC reviews these documents to ensure that due diligence has been taken and that investors will be provided with sufficient and most importantly reliable information about their potential investment in the company.

Once the SEC approves, the issuing company and the underwriter decide on a date for the IPO, the number of shares to be sold and the price. Once the stocks hit the secondary market, the issuing company no longer benefits from increased prices; therefore, the price set for the IPO is the main generator of capital. The price of the share depends on the success of the underwriter’s marketing scheme prior to the IPO as well as the condition of the market.

IPOs are often underpriced. Underwriters will often do this to ensure that the stocks sell to investors during the IPO instead of lingering, driving the price of the stock down. This strategy attracts many investors keen to make a significant return in the shorter term.

Once the stocks are on the market, the underwriter provides analyst recommendations and assists in stabilizing the stock price by ensuring the market for the stock is strong. One way the underwriter might achieve this is by buying the stock at or below the IPO price in the period immediately following the IPO to create stable demand, says Andrew Kroger.

The final phase of the IPO process is the transition to market competition. Once the frenzy quiets and the SEC-mandated “quiet period” ends 25 days after the IPO, the stock becomes reliant on market forces. The underwriter can then estimate the earnings and valuation of the issuing company, thereby fulfilling their contractual obligations.

Final Thoughts from Andrew Kroger

While an IPO can be an exciting investment opportunity for the public, it is a serious decision for any issuing company. Care must be taken at every step, says Andrew Kroger. An IPO can be a make or break moment, making companies ever more fascinating to follow.

This article does not necessarily reflect the opinions of the editors or management of EconoTimes.