What is an IPO?

Hello dear readers!

In this short article, you will learn what an IPO is, how a simple investor can make money on it, and why high-tech companies refuse to be listed on the stock exchange.

What is an IPO (Initial Public Offering)

If you've seen the movie The Wolf of Wall Street, you've heard that an IPO is the very first public offering of a stock. IPO in the original language sounds like Initial Public Offering, «the first public offer (shares)».

The entry of the company's securities on the exchange market is necessary for additional attraction of finance. They are necessary for further business expansion, investment, so that the company can make money even more efficiently and attract highly qualified and talented specialists to its staff.

After the shares are traded on the market, their value will be more objectively assessed, and the company will become public, which implies the openness of all reporting. This affects the prestige of the organization and its popularity.

What is a People's IPO

People's IPO has a number of fundamental differences from the usual. Firstly, the main participants in this process are state-owned companies, it is their shares that are listed on the stock exchange. The state, leaving behind a controlling stake, sends the rest for sale to the population of its country. It turns out that the process of people's IPO is similar to privatization. Secondly, the buyers of such securities can only be residents of the state whose enterprise places them.

IPO organization

To start the placement procedure, they resort to the services of a special person — an underwriter. In general, an underwriter is a specialist who deals with insurance, risks of financial losses, acts as a guarantor in transactions.

But in the securities market, his task is to manage the issuance and distribution of shares. Why can't you implement everything yourself, arrange a PR campaign, settle all legal issues and substitute a bag for money?

In practice, the IPO procedure is more complicated than in theory. Therefore, the underwriter, represented by an investment bank, a broker or an entire stock exchange, withholding a considerable commission (up to 7% of the placement amount), deals with the legal aspects of the process.

After the agreement between the joint-stock company and the underwriter is concluded, the latter submits an investment memorandum to a special authority that controls the IPO process.

Why IPO is better than other ways to raise capital

The attracted capital of shareholders is the company's own capital, and its maintenance is always cheaper than borrowed capital. Shareholders only need to pay dividends, which depend on profits: if things do not go well, there will be no payments. But if managers use borrowed capital, for example, take a loan from a bank, then in any case you will have to pay interest and repay the loan amount, because the bank doesn’t care why you don’t have money.

Pros and cons of an IPO

Completion of such a complex procedure is necessary for the large-scale growth of the company, popularization of its brand and attraction of new capital. Once a JSC goes public, there are a number of benefits:

  1. The probability of a raider capture will decrease.
  2. The opportunity to sell the company at the peak of its market value will become real.
  3. This will make potential mergers and acquisitions less accessible.
  4. By issuing shares, owners can manage the structure of the authorized capital, which affects business management processes.

The dubious advantage of an organization whose shares are listed on the exchange market is the mandatory division of mandatory audit and internal control, which is a plus for users, and for the company itself results in additional control over the financial side of the activity.

The main drawback is the huge risk that owners and top management consciously take, because after an IPO, revenues can drop sharply due to the unpredictability of the market and its behavior with a new participant. What is important is the considerable cost of the procedure itself, the time for its preparation, implementation.

Why do companies need an IPO?

  1. Earnings. Selling shares is a profitable business. Successful public offerings: Lyft (the company raised $2.34 billion), Pinterest ($1.4 billion), Zoom ($350 million).
  2. Increasing the prestige of the company. As soon as the shares are listed on the stock exchange, the business becomes even more recognizable, it is easier for other large entrepreneurs to work with it.
  3. Transparency. Entering the public market requires the «purity» of the company in finance, personnel, and management. This state of affairs inspires confidence on the part of potential investors and partners. It is easier for public companies to take advantage of government programs or get a large loan.

Since an IPO is so great, why don't all companies go public?

  1. High cost. Expenses are required for expertise, interest to the bank, an advertising company and other expenses, which in the end can reach several million.
  2. Risks. There is no guarantee that the company's shares will be in demand and make a profit. For this reason, IPOs are used by those who have already established themselves in the market.
  3. Time. It is necessary to conduct a detailed analysis and prepare a lot of documents. The preparatory stage alone can take several years.
  4. Requirements. Exchanges set strict criteria for companies on finances, reporting, prospects and so on. For example, according to some exchanges, the value of a business before an IPO should be at least $50 million.

Stages of initial placement

The time to fulfill all the requirements for entering the stock exchange can stretch from 1.5 to 4 years. During this period, all necessary documents are put in order, all checks for compliance with the law are completed.

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Stage 1. Primary evaluation of JSC activity. It includes a complete analysis of the activities of the financial department (financial directorate), verification of all forms of financial statements (financial statement, balance sheet, income statement), its comparison with the real situation, analysis of all links in the organizational structure of the company, as well as legal subtleties.

Stage 2. Search for an underwriter, conclusion of an agreement with him. At this stage, a decision is made on how many shares will be issued, a price range is set, a roadmap for the procedure is developed: a valuation of the company in the literal sense, an analysis of the demand for future securities.

Stage 3. Finding an entry point to the market. This is the ideal moment when you can issue shares in circulation. This moment depends on many factors: time of year, market conditions, other companies entering the market. To build demand, you need to find the best time when the stock will attract the maximum interest from investors.

Stage 4. The beginning of the trading period on the stock exchange. The final stage, the most important and lengthy. The further success of the IPO depends on how the first hours pass, whether the price falls or takes off.

Preliminary work

During the preliminary stage, it is necessary to evaluate all financial and economic activities, to identify existing weaknesses. They need to be eliminated before the final decision to enter the stock exchange.

Search for an underwriter

The legislation does not stipulate the obligation to involve an underwriter in the IPO process, but companies often turn to investment banks or brokers for help. After all, a specialist can reduce time and costs, saving money for the employer. The issuing company, the bank must agree on important aspects of cooperation:

  1. Specify the amount to be raised as a result of the IPO.
  2. Determine the number, price and type of shares to be issued.
  3. Agree on the payment for the services of an intermediary, the procedure for remuneration.

If all these points are accepted, it becomes necessary to fix them on paper.

Signing an agreement with the underwriter

An underwriting agreement is an agreement signed by the parties, fixing in it the previously agreed provisions on the obligations of the bank, the amounts of the discount. Depending on these provisions, the agreement can be of two types:

  1. Firm Commitment. Here, the underwriter assumes all the risks associated with the sale of securities, undertaking to pay the approved amount to the issuing organization, regardless of the success of the commercial campaign.
  2. Maximum effort (Best Efforts agreement). In this case, the risks and responsibility remain with the company, the bank only needs to deal with the implementation, using the maximum of its funds and capabilities.

A formalized agreement, like any other contract, contains the following points:

  • the subject of the transaction;
  • rights and obligations of the parties;
  • terms;
  • resolution of conflicts of interest;
  • material side;
  • the responsibility of the parties;
  • final provisions;
  • requisites;
  • signatures.

Due Diligence

Applicable to the IPO procedure, Due Diligence is the verification of the authenticity of all data on the activities of the issuer, including all types of reporting and management structures. Depending on the object of verification, business DD and legal DD are distinguished. The first group deals with the validation of data on business administration, market assessment, verification of the rationale for forecast growth. The second group delves into the study of financial statements.

In different countries, different forms of reporting are subject to verification, in most cases these are IFRS data: Europe, the CIS, in Russia RAS norms were previously used, and in the USA there was GAAP, but in the process of globalization, companies come to unified standards of audited accounting and financial statements in accordance with the International Financial Reporting Standard. Upon completion of Due Diligence, a “comfort letter” is issued containing information about the outcome of the check.

Publication of investment memorandum

Investment memorandum (preliminary prospectus) — shows potential investors full information about the company:

  1. The history of its creation, activities.
  2. Prospects and risks associated with investing in this business.
  3. The purposes for which the funds received from the sale of securities will be directed.

The last point is considered the main one.

Road show

This is a key moment in attracting investors. The Road Show is a tour in which the company's top management gives presentations, answers questions from potential shareholders about the organization's activities, its prospects, risks, directors' plans for the development and scaling of branches in other countries.

Approximately 20 minutes of performance should be of maximum interest to future partners from different parts of the world. The road show is usually held in the largest financial centers of the world: New York, London, Paris, Moscow, Stockholm, Vienna, Tokyo and Hong Kong.

Exchange selection

An exchange is carefully chosen for listing stocks. The key here is to understand the difference between global stock exchanges and define your own criteria that suit your company. The biggest players:

  • London Stock Exchange (LSE);
  • New York Stock Exchange (NYSE);
  • NASDAQ;
  • Hong Kong Stock Exchange (HKEx).

In order to consider listing on one of these exchanges, a very large number of indicators must be met: increased requirements for audit and disclosure of information, the requirement for the level of profit and the period of activity.

Registration on the stock exchange and in regulatory bodies setting the IPO date

The necessary and convenient IPO date is 95% dependent on the market, as you need to take into account other large IPOs from related areas (so that they are not in the coming dates), as well as the general market situation and the economic state of the segment (recession, stagnation or growth).

Prospectus approval

Final, updated and approved form of the prospectus. After the release of this document, the issued securities are admitted to trading, and the trader's race begins. The entire financial world watches the quotes of shares of large companies in the early days, it is during this period that the price changes significantly.

How to make money on an IPO for an ordinary investor

Very often you can see outdoor advertising of brokerage services. In Russia, many banks provide them: Tinkoff, Otkritie, Sberbank; investment companies: FINAM, Alpari and a large number of other, less well-known ones. How to withdraw a portfolio in plus? It is necessary to correctly assess the risk of investing money both in your own portfolio with already quoted securities, and in an IPO. Consulting agencies will help you make a choice.

Based on the analysis of reports and the market, experts will tell you exactly where to invest. You must understand that the risk is very high, and you are responsible for the decision you make. But the acquisition of diversified products will reduce possible losses.

What gives access to the stock exchange for investors

Listing of shares on the stock exchange and publicity makes all reporting available to investors and guarantees transparency of activities. The procedure makes it possible to earn not only on the payment of dividends, but also on the growth of the market value of shares.

Investment diversification

The best way to save and increase your assets is risk diversification. Adopt the principle of «keep eggs in separate baskets». When compiling your personal portfolio, try to choose securities of different issuers from each other so that the companies do not correlate with each other. So, if one segment goes down, then others will continue to bring you income.

Orientation to the long term

Warren Buffett said that you need to own stocks for at least 10 years. And he was right: in the long run, the investor makes good money on compound interest. But how to ensure this growth? It is necessary to choose organizations whose activities will be relevant in the future. For example, IT-technologies, nanoengineering, medicine, etc. It is then that the opportunity to increase capital dozens of times at moderate risk becomes available.

Easier entry

What makes it profitable to buy shares during an IPO? Of course, because of the price of their purchase. Prior to listing on the stock exchange, the value of some equity securities may be several times lower than the market value. But it is worth remembering the high risk and the fact that you can lose your investment or pretty shake your nerves during a “low start”.

Why not all companies go public

It can be seen that the number of public and existing companies is different. Not everyone is in a hurry to enter the stock exchange: it is expensive and not always necessary. There are companies that lack funding and credit. And bureaucracy and a huge amount of work on the IPO procedure can only negatively affect business growth.

Examples

Over the past 15 years, the US public company market has lost more than half of its participants. Many IT companies do not want to go public and work quite well without an IPO. Since 1999, when almost 400 technology businesses were listed, the number of such companies has decreased by almost 40 times.

Successful and unsuccessful IPOs

It is very difficult to single out specific criteria to say whether the listing was successful or not. Not always with a positive result at the beginning we get a successful completion. We are talking about listing failures.

For example, Toys «R» Us (an American children's toy trading company) raised a huge amount of money at the very beginning when trying to list its shares, but failed miserably, unable to cope with the amount of work. As a result, the network declared itself bankrupt in 2018.

The largest IPOs in the world

The most expensive IPOs in the world:

  • Chinese public company Alibaba Group (2014, $25 billion);
  • one of the largest banks in China Agricultural Bank of China (2010, $21.1 billion;
  • transnational company VISA, Inc., providing payment services (2008, $19.7 billion);
  • social network Facebook (2012, $18.4 billion).

Exchange-traded funds on IPO

The purpose of an exchange-traded fund is to capitalize on the volatility of stock indices, which include companies that have recently gone through an IPO. In simple words, speculate on the price. Well-known large exchange-traded funds that specialize in IPOs:

  • First Trust US Equity Opportunities ETF (FPX);
  • First Trust International IPO ETF (FPXI);
  • Renaissance IPO ETF (IPO);
  • Renaissance International IPO ETF (IPOS).

How to Identify a Troubled IPO

Too high growth rates of operating and net income during a long period of growth, high frequency of forecasts for the prolongation of such results is one of the signs of a troubled IPO. I also note the use of the direction of activity at the moment “on the wave of demand” without clear ideas about the further development of the business.

Comparison of IPO and ICO

An ICO is an initial offering of a cryptocurrency. The meaning of these two processes is the same: to collect a pool of investors and direct their funds to development. The fundamental differences lie in legislative regulation: IPOs have more regulatory regulations and requirements for the issuer than ICOs.

Conclusion

I tried to reveal to you the maximum of my knowledge about the concept of the first public offering of shares (IPO). Despite the disadvantages, this procedure has many advantages. And, if you are directly related to business, then the choice is yours!

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