By Ryan Prete, Jun 27, 2023
Every year, scores of companies list their shares on the public markets in hopes of raising capital, offering up pieces of their businesses to accredited and retail investors. Holding an IPO is a lengthy and time-consuming decision; it’s also an exclusive club, as not every business that wishes to go public gets their wish granted. In fact, there have been only around 6,000 IPOs since 2000. In this piece, we’ll explore the steps behind an IPO, what it takes, what alternative paths there are to a traditional IPO, pre-IPO investing, and more.
Table of Contents
An initial public offering, or IPO, is defined by the process through which a privately held company offers its shares to the public for the first time, essentially allowing institutional and retail investors, or the general public, the opportunity to own a piece of said company. Deciding to go public is a huge decision for a company, and comes with a numerous step, including first and foremost, hiring an investment bank to underwrite an offering and acting as a chief “assistant” in the IPO process.
The main purpose of an IPO is for a company to raise capital by selling shares of its business to the general public. By doing so, a company can generate funds which can they be used for several purposes, including business expansion, debt repayment, research and development, or acquisitions. Further, an IPO can provide liquidity to a company’s existing shareholders—such as employees or early investors—that invested in the company when it was privately held.
The IPO process is a complex one, and the time length depends on many factors. If the team managing the IPO is well organized and efficient, then the total process can be expended to take six to nine months for a company to complete its public debut.
When a company decides to go public, it normally follows a selection process to choose an underwriter—synonymous with an investment bank—that will underwrite the offering; assisting in the IPO process. This selection is a crucial and critical decision which can make or break the success of the IPO. During the selection process, companies will look at an investment bank’s reputation, spending great amounts of time on due diligence. Once an underwriter is picked, the company and the underwriter formally agree on terms, known as an underwriting agreement. This agreement also includes the amount of money the underwriter receives for its services, which typically ranges from five to eight percent of the IPO proceeds.
Due diligence is a very standard process, used for any investment, and always for IPOs. In the IPO process, due diligence refers to a rigorous and comprehensive investigation conducted by a number of parties involved in the IPO of a company, including its legal team, financial advisors, underwriters, and regulators. The purpose of due diligence is to verify the accurarcy and reliability of information about the company and its financials, operations, and other necessary information disclosed in its IPO documents.
The IPO process involves the preparation and filing of a number of various documents, submitted to regulatory authorities and stock exchanges. The exact documents needed can depend based on the location of the company and other various requirements. Here are the common documents typically prepared and filed:
The contract between the company and the underwriters—the investment bank—which outlines the terms and conditions listed above.
This document, filed by the underwriter, is a preliminary prospectus containing information on the company’s operations, but doesn’t include share price, number or shares, or other similar information.
These refer to various legal and financial disclosures including management discussions and analysis, risk factors, audited financial statements, legal proceedings, material contracts, and more.
These documents refer to a company’s bylaws, articles of incorporation, board committee charters, code of ethics, and more.
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This filing refers to which stock exchange, if applicable, a company intends to list its shares on, such as the Nasdaq, NYSE, and others. This application may include information about a company’s corporate structure, financial information, compliance requirements, and other information.
These documents refer to filings consisting of investor presentations, roadshow materials, marketing campaigns, press releases, and other material that will generate and grow awareness about the IPO to a pool of potential investors.
The most widely-know and referenced IPO filing, this comprehensive document is the primary document filed to the Securities and Exchange Commission, therefore initiating the IPO process. It contains droves of detailed information, including the company’s business model and purpose, its financials, risks, management structure, and much more information required by the SEC.
IPO pricing is determined and set through a lengthy process which involves the company, its underwriters, and the consideration of investor demand and of current market conditions. A price is determined once the parties agree to a number that can generate a targeted proceed goal while also being attractive to potential investors. When it comes to determining a company’s valuation, a handful of relative valuation methods are used to value a company, including:
A valuation method that examines the value of an investment based on its projected future cash flows.
A valuation method that compares and contrasts companies that are already publicly traded and which exist in a similar sector and location—and also with comparable revenue and market capitalization—to the company involved in the IPO process.
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a valuation method which examines historical prices or completed deals within the private markets, which also involve similar companies that are already public.
Over the past decade, a growing number of companies have chosen to forgo the IPO route, instead opting for alternative methods to listing on the public market.
In a direct listing, or direct public offering, a privately-held company will go public be seeling shares of its business to investors on a stock exchange without holding an IPO. This process eliminates the need for an IPO underwriter, which can save the private company both time and money. This process has historically been utilized by small businesses that might be budget-conscious, which seek to avoid the large fees that come with holding a traditional IPO. As so, a direct listing might not reach the same large pool of investors that a traditional IPO does
A special purpose acquisition company, or SPAC, is a special type of company formed with the sole purpose of acquiring or merging with an existing private company to take it public. SPACs are commonly referred to as “blank check companies” because they exist without any specific business operations or assets.
When a company gets acquired by a SPAC, it goes public without paying the high costs of an IPO, as the fees and underwriting costs are handled before the target company ever gets involved. SPAC mergers became especially popular during the COVID-19 pandemic, as a soaring public market had private companies rushing to go public. There are significant risks when going public via SPAC merger, including investors contributing capital to a SPAC without knowing which specific company it will acquire, less due diligence and transparency due to a SPAC merger’s quick turnaround, shareholder dilution—as SPACs tend to own a 20% stake in the company it acquires—compressed timeline for public company readiness, and more.
Investing in a company pre-IPO can come with some advantages. There are a limited number of platforms that allow accredited investors to invest in a company pre-IPO—Linqto is of course one of them. Some advantages include: Potential for higher returns, opportunity to participate in a company’s early growth stages, the potential to access shares at a lower valuation, access to new and promising sectors, ability to invest in companies that promise to disrupt or innovate old-school industries, and the ability to diversify an investors portfolio.
Some risks of investing pre-IPO include: limited information and limited-access to financial disclosures to the investor, higher risk and uncertainty of investments, Illiquidity and lock-up periods for investors—meaning that investors may have to hold onto to pre-IPO shares for longer periods of time before being able to sell them—constant valuation changes of a pre-IPO company, and more.
At Linqto, we seek to educate accredited investors on market topics of all variations. Read more about our latest series on IPOs by clicking here.
Can a Company IPO Twice?
Yes, it is possible for a company to conduct multiple IPOs and go public more than once. This is known as a secondary IPO or a follow-up offering. A secondary IPO occurs when a company that is already publicly traded decides to offer additional shares to the public.
There are several reasons why a company may choose to conduct a secondary IPO:
1. Capital Raise: The company may seek to raise additional capital to fund its growth initiatives, acquisitions, research and development, or other expansion plans. By issuing more shares to the public, the company can generate funds that can be used for various purposes.
2. Existing Shareholders’ Exit: In some cases, existing shareholders, such as early investors, founders, or employees, may want to sell their shares to realize their investments or monetize their equity holdings. A secondary IPO allows these shareholders to sell their shares on the public market.
3. Enhancing Liquidity: By conducting a secondary IPO, a company can increase the liquidity of its stock. The increased trading volume and broader investor base can lead to improved liquidity, making it easier for shareholders to buy or sell shares.
4. Increasing Public Awareness: A secondary IPO can raise the company’s profile and increase public awareness. It provides an opportunity for the company to gain additional exposure, attract new investors, and enhance its visibility in the market.
What Happens When a Public Company is Taken Private?
When a public company is taken private, it means that the company’s shares, previously traded on a public stock exchange, are no longer available for trading by the general public. Instead, the company’s ownership is transferred to a group of private investors or a single private entity. This process is often referred to as a privatization or going private.
Here’s an overview of what typically happens when a public company is taken private:
1. Acquisition proposal: A group of investors, which can include management, private equity firms, or other entities, makes a proposal to acquire all outstanding shares of the public company. This proposal is presented to the company’s board of directors.
2. Negotiation and Due Diligence: If the board of directors deems the acquisition proposal favorable, negotiations begin between the acquiring group and the company’s board or a special committee representing shareholders. During this stage, due diligence is conducted to assess the company’s financials, operations, and legal matters.
3. Shareholder Approval: Once the terms of the acquisition are agreed upon, the proposed transaction is presented to the company’s shareholders for approval. The shareholders vote on whether to accept the offer. Typically, a majority of shareholders must approve the privatization for it to proceed.
4. Financing and Transaction Closure: The acquiring group secures the necessary financing to complete the transaction. This can involve obtaining debt financing, equity contributions from the investors, or a combination of both. Once the financing is in place, the privatization is executed, and the public company becomes privately held.
5. Delisting and Ownership Transfer: After the privatization is finalized, the company’s shares are delisted from the public stock exchange, and trading in those shares ceases. The ownership of the company is transferred to the acquiring group, and the company’s shares are no longer available for public trading.
Ryan is a financial writer for Linqto, known for his original blog content, articles, and other works. He previously worked as a financial writer at PitchBook Data, where he covered private equity, and as a reporter for Bloomberg in Washington D.C.,where he reported on tax policy. Ryan has also reported on cybersecurity policy for Inside Washington Publishers. His work has been featured in The Wall Street Journal, Axios, Yahoo News, and Reuters. He is a graduate of the University of California, Santa Barbara.
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