Issuing process of an IPO
Feb 5th, 2012
Let’s talk about the process though which a private company issues an IPO.If you want to brush up your knowledge on the basics of an IPO, you can follow the link.
We will try our best to understand the process in theeasiest language possible. The process illustrated below may differ in differentgeographies, but largely remains the same.
For illustration purposes we assume ABC to be a company issuing an IPO in the market.
Investment Bank: First of all ABC consults an Investment Bank, which will be responsible for managing the entire process,from the analysis work to the selling of shares and even afterwards in somecases.
The analysis work by the Investment Bank includes:
- Assess the company’s assets and debts and itsoverall value.
- Decide on the amount of capital to be raised.
- Negotiate fees and analyse all other costs to beincurred.
- Decide on a commitment to the sale of stocks inthe market.
Apart from the investment bank, ABC also involves lawyers tolook into the legal issues while issuing an IPO. By now this is clear that anInvestment bank will be helping ABC to sell the stocks and will also advise howmuch capital can be raised and what will be the price per stock.
But what happens if there are not enough buyers of the stocks that will be made available for the investors in the IPO?
At this point we mention about an agreement between the bankand ABC. This agreement can be of two types.
- Firm Agreement
- Best Effort
Although both the terms are very much self explanatory, let’sjust talk about them very briefly.
The firm agreement guarantees ABC a fixed capital. ABC will sell the entire equity to the bank and then it’s the bank’s responsibility to sell the equity in the market. If the bank is unable to sell the entire equity, it does not concern ABC. The bank would keep the unsold equity with them for the time being. ABC would sell the equity to the bank at some discount to the original price decided upon. Thus the bank gets its own share or it fees by getting the equity at a discount and selling it at the previously decided price without discount.
In case of the best effort agreement, the bank does not guarantee raising the entire capital. If it happens so, that all the stocks could not be sold, ABC would be able to raise only a portion of the planned capital. In this case the bank’s fee would be a percentage of the capital raised. Thus the bank has the incentive to sell as much shares as possible.
The important point to note here is that the overall fee for a firm agreement is understandably more than the best effort agreement.
This is sufficient enough to know about the agreements to go ahead. Let’s come back to the process again.
Registration: After an agreement is reached, the IPO has to be brought to the notice of a market regulator, e.g. SEBI, Securities Exchange Board of India. Only after the regulator approves can an IPO be brought to the market. During all this time the bank and the company has to maintain confidentiality from the public about the IPO.
The Prospectus: The bank has to draft a list of all the information that an investor needs to know about ABC while making a decision to invest in its stock to the regulator. This will also include the potential risk involved if an investor chooses to buy the shares. The next step as anybody could guess by now is that the regulator will investigate the declarations made by the bank about ABC. If the IPO is approved the date for the IPO is decided, the effective date, otherwise the issuer, ABC and the bank has to make amendments to the draft, which will again be scrutinized by the regulator.Only when the regulator approves the IPO, the bank rolls out a final prospectus of the IPO.
Only when the effective date is fixed, the price at which the stock is offered is decided. The price is decided based on the current market conditions and initial response of the investors.
The investors are required to carefully read the prospectusbefore making a decision to invest in ABC’s share. It is only through the prospectus that an investor could know how much risk is involved in investing in this particular share.
Now the question is how will the investors come to know about the IPO? The answer to this is as simple an answer you could think.
Marketing: That’sit. The management team of the issuer, ABC and the bank travel for a certainperiod of time giving presentations to the potential investors. They inform the investors about the company’s business plans, the reasons for the IPO, the company’s history. At this point they are forbidden to discuss about the potential gains.
As mentioned earlier, the final price is decided after a good observation of the initial response of the investors. Once the price is decided upon a final prospectus is prepared including the share price.
The D Day: The final prospectus is filed with the regulator with all the relevant information in it and the shares are made available to the investors. At this point no active promotion can be conducted by ABC. This period extends over a certain period of time after the issue.
Closure: An IPO is closed in a couple of days after the shares are sold out. In the end, basedon the type of agreement, the bank receives its share and an IPO is closed.
Well, this is all about the process followed while issuing an IPO in plain English.
Just a financial term to end with;
Underwriter: This term now can be easily understood after knowing about the involvement of an investment bank in the issuing of an IPO. This investment bank is called the underwriter bank.
‘A company that administrates the public issuance and distribution of securities from a corporation or other issuing body is called an underwriter. An underwriter works closely with the issuing body to determine the offering price of the securities, buys them from the issuer and sells them to investors via the underwriter’s distribution network.’
This definition is taken from investopedia which should not be very difficult to understand now. 🙂