Initial Public Offerings

"Green Shoe Provision" or Over-Allotment Allocation

a method to manage underwriter risk through pricing influence with an option that allows the underwriter to issue more stock, usually amounting to 15% of the original offer size

lockup restriction

a restriction that prevents existing shareholders from selling their shares for some period

Auction IPO

A method of selling new issues directly to the public. Rather than setting a price itself and then allocating shares to buyers, the underwriter in an auction IPO takes bids from investors and then sets the price that clears the market.

1)better access to capital, 2)wealth creation, 3)greater liquidity 4)prestige and glamour

Advantages of going public?

About 23% underperform the market after 3 years, About 44% underperform the market after 5 years

Although shares of IPOs generally perform very well following the IPO, what is their long term performance?

1)costs of going public (e.g., initial offering cost, ongoing operational requirements like SOX), 2)increased public scrutiny from earnings relative to analyst expectations, 3)pressures on management forcing short-term decision-making, 4)loss of independence for owners/founders

Disadvantages of going public?

Best-Efforts Basis

For smaller IPOs, a situation in which the underwriter does not guarantee that the stock will be sold, but instead tries to sell the sock for the best possible price

easier to sell shares in the future and give employee stock options, also puts market value on future offerings

How do IPOs impact liquidity?

If the IPO is successful (prices go up), then the issuer does raise more money since the underwriter will exercise the option and more shares are sold into the market. If the price is falling, then the underwriter enters the market to buy back shares and stabilize the price.

How does the Green Shoe provision lower risk?

1)valuation models, 2)evaluate stock demand with book building, 3)set IPO price day before by underwriters and mgmt

How is the price of an IPO established?

1) amount of money to be raised, 2) not all of offered shares will be sold

How many shares to issue depends on what?

the underwriter will NOT exercise the right to buy the additional 15% of shares.They will enter the market and buy back shares to cover the short sales from before. Since the price has fallen, they can buy back the shares for less than they sold them for, making a nice profit, assuming they cover all of the short sales

If the share price goes down, how is the green shoe option used?

the underwriter exercises the right to buy the additional 15% of shares at the IPO price minus the spread. It then uses those shares to cover the sales from before, making a nice profit (because they will only do this is they sell for more than IPO price - spread.)

If the share price goes up, how is the green shoe option used?

mgmt distraction results in operational shortcomings that impact investor confidence

In preparation for an IPO, commitment of time and energy by management team is significant. How can this impact IPO pricing?

in general, easier to meet filing rules for NASDAQ

Is it easier to list on NASDAQ or NYSE?

Better access to capital

Public companies typically have access to much larger amounts of capital

existing shareholders who received cash or created shares whose proceeds go to the company

Shares come from what two sources?

Firm Commitment

This is the most common type of offering where an agreement between an underwriter and an issuing firm in which the underwriter guarantees that it will sell all of the stock at the offer price

18.3% in the US

Underwriters typically set the IPO price such that the average first-day price is

1)firm commitment, 2)best-efforts, 3)Auction IPOs

What are the 3 types of offerings?

set too low, all shares sell but company receives suboptimal capital. set too high and not all shares are sold and agents will lose transaction commissions and extend sale length

What is the impact if IPO is too high or too low?

NYSE for $250,000 to list, then $46,150 per year, or NASDAQ for $125,000 to list, then $37,500 per year

Where do you list?

syndicate

a group of underwriters who jointly underwrite and distribute a security issuance to REDUCE RISK

registration statement

a legal document that provides financial and other information about a company to investors prior to a security issuance

roadshow

company's senior management travel around and highlight financial statements, pitch future growth potential, and how the money will be used to institutional investors like mutual funds and pension funds

1)reputation, 2)distribution (move product), 3)after market support for seasoned offerings (e.g., research analysts dedicated to the company, market making to provide liquidity, financial advice on dividends, or M&A)

considerations choosing an underwriter

pre-IPO shareholders bear the cost of underpricing. In effect, these owners are selling stock in their firm for less than they could get in the aftermarket.

how are per-IPO shareholders affected by underpricing

benefit from the underpricing as it allows them to manage their risk

how are underwriters affected by underpricing

early investors get to cash out, especially a goal of any venture capital investor

how do IPOs create wealth?

1)estimating CFs based on very limited history, 2)will use multiples of dissimilar industry's in a similar position or lifecycle as other recent IPOs

how is valuing IPOs different for IPOs as compared to other firms?

get their money faster without the cost of the IPO but they are guessing what the market valuation is before it goes public

ideally a company will get acquired rather than an IPO for venture capitalists. why is this?

primary shares

new shares available for public offering that raise new capital where issuing firm receive the proceeds, less fees

final prospectus

part of the final registration statement prepared by a company prior to an IPO that contains all the details of the offering including IPO price and share origin

preliminary prospectus (red herring)

part of the registration statement prepared by a company prior to an IPO that is circulated to investors before the stock was offered.

75%

research shows on average that __% of IPOs experience an increase in share price on the first day (only 9% experience a decrease).

secondary shares

shares sold by existing shareholders in an equity offering where they receive proceeds, less fees (ie., early investors, founder, and employees and venture investors)

lead underwriter

the primary investment banking firm responsible for managing a security issuance

1)make decision to go public, 2) pick underwriter, 3)where to list, 4) regulations, filings, disclosures, 5)marketing the offering, book building, 6)pricing the offering

the steps of an IPO process?

underwriting fee or spread

the ~7% fee a company pays to its underwriters that is a percentage of the issue price of a share stock

try to better define the demand for the IPO and effectively set price

typically a price range is provided on the red herring to do what?

6-16% of the Issue Proceeds

what is the approximate cost of issuing securities in an IPO?

investment bankers

who are IPO "underwriters"

85-90% go to institutions and the rest go to individual investors

who gets allocated shares in the IPO?

3 years of publicly audited financial statements must be maintained

why do accountants have job security in public companies?

Most IPO companies are not household names. They need to sell themselves and their story to investors

why is the roadshow critical for IPO companies?