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1. INITIAL PUBLIC OFFERINGS

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The first time a corporation sells shares on a listed exchange is known as an initial public offering (IPO). After the IPO is over, companies might raise more money later on through secondary or follow-on offerings, which could reduce the number of current owners.

 

Along with large, established privately owned companies aiming to go public as part of a liquidity event, younger businesses searching for funding to grow frequently launch initial public offerings (IPOs). A highly particular set of events take place during an IPO, which the chosen IPO underwriters assist: 

 

• The lead and additional underwriter(s), attorneys, certified public accountants (CPAs), and Securities and Exchange Commission (SEC) specialists compose an external IPO team.

• The company's financial performance, operational specifics, management background, risks, and anticipated future course are all included. This is included in the prospectus for the company, which is distributed for evaluation.

• The financial statements are submitted for an official audit.

• The company files its prospectus with the SEC and sets a date for the offering.

 

WHAT IS AN INITIAL PUBLIC OFFERING (IPO)?

 

1. An initial public offering (IPO) is the term used in the financial markets to describe the procedure by which a privately owned firm first makes its shares available for purchase by the general public.

2. A corporation "goes public" when it basically becomes a publicly listed company with shares for sale on a stock exchange, as opposed to being privately owned by a select group of investors (such as founders, venture capitalists, and private equity firms).

3. The selection of underwriters, or investment banks that assist with the initial public offering (IPO), setting the offering price, and filing regulatory documents with the Securities and Exchange Commission (SEC) to disclose information about the company's operations and financial health are just a few of the crucial steps in the offering process.

4. An opportunity to invest in a business at an early stage and maybe reap the rewards of the company's share appreciation as it expands over time is presented by initial public offerings (IPOs). But there are also a lot of hazards associated with initial public offerings. For instance, not all startup businesses grow into established ones, hence the value of certain initial public offerings (IPOs) eventually drops.

5. A further consideration is that initial public offerings (IPOs) may have a cap, with the possibility that institutional investors and high-net-worth people with priority access will purchase the bulk of the shares. Because of this, it's critical to comprehend the IPO allocation procedure and assess whether a particular IPO fits into your overall investment plan.

 

HOW DO IPOS WORK?

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The process of an initial public offering, which starts with the company's decision to go public and ends with its listing on a stock exchange, is intricate and heavily regulated. To guarantee a successful launch in the market, this process usually necessitates thorough planning, cooperation with underwriters and regulatory bodies, and market study.

 

The primary steps in the IPO process are highlighted in greater detail below:

 

• Company Decision: In order to raise money, the company's shareholders, board of directors, and management choose to undertake an initial public offering (IPO).

• Engagement of Underwriters: To help with the IPO process, the firm usually chooses one or more investment banks or underwriters. Among other things, these underwriters offer advice on marketing, valuation, regulatory compliance, and share distribution to investors.

• Due Diligence and Documentation: In order to generate the financial statements, audit reports, and disclosure papers that regulatory authorities like the Securities and Exchange Commission (SEC) require, the company undertakes extensive due diligence.

• Filing Registration Statement: To give prospective investors comprehensive information about its finances, operations, management, and risk factors, the company files a registration statement with the appropriate regulatory body (Form S-1, for example, in the United States).

• Pre-Marketing and Roadshow: In order to determine an approximate price range for the initial public offering (IPO), the underwriters conduct pre-marketing operations. They frequently hold roadshows as part of this process, where corporate officials pitch the company to institutional investors.

• Pricing and Allocation: The underwriters decide on the final offering price and distribute shares to institutional and retail buyers based on input from the roadshow. The goal of this method is to balance supply and demand.

• SEC Review: The registration statement is examined by the SEC to ensure that it complies with all applicable regulations and securities laws. The business might have to respond to any queries or issues brought up during this review. 

• Trading Debut: The company's shares are listed on a stock exchange and public trading starts on the day of the planned IPO. The ultimate offering price and the opening market price, however, might not match.

• Post-IPO Reporting and Compliance: The business needs to comply with continuous reporting regulations, which include filing annual and quarterly financial reports as well as disclosing significant events.

• Lock-Up Period: Lock-up agreements, which prevent insiders and other early investors from selling their shares for a predetermined amount of time, may apply to them. This is carried out in an effort to lessen the likelihood of undue selling pressure in the aftermath of the IPO. 

• Market Performance: Investors, analysts, and the corporation all keep a close eye on the stock's performance in the secondary market. The company's financial performance, the state of the market, and the overall state of the economy could all have an impact.

 

WHY DO COMPANIES GO PUBLIC (IPO)?

 

1. Going public through an IPO is a significant decision for a company and its stakeholders. It involves selling shares to the public for the first time and listing them on a stock exchange.

2. Companies may choose to go public and conduct an Initial Public Offering (IPO) for various strategic reasons, as outlined below:  

• Access to funds: By offering shares to a broad spectrum of investors, initial public offerings (IPOs) offer a significant means of raising funds that can be used towards research & development, growth, expansion, and debt reduction.

• Brand exposure: By increasing a company's reputation and exposure in the marketplace, initial public offerings (IPOs) can draw in partners, suppliers, and customers.

• Attracting personnel: Stock-based compensation plans are a common way for publicly traded organizations to draw in and keep top personnel.

• M&A Dynamic: Public firms are able to facilitate mergers and acquisitions (M&A) by using their shares as a form of payment.

• Exit Strategy: By offering a way to monetize their investments, going public can act as an exit strategy for venture capitalists, entrepreneurs, and early investors.

• Debt Refinancing: The company's overall financial situation can be improved by using the revenues from the IPO to pay down debt, which will lower interest costs.

• Growth Potential: Public businesses may be able to support future investment and expansion by issuing more shares as a form of payment for future financing.

• Increased Financial Flexibility: Bonds, convertible debt, and secondary offerings are just a few of the funding choices available to public corporations.

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BENEFITS OF AN IPO

 

1. For businesses and its stakeholders, going public through an Initial Public Offering (IPO) has several attractive advantages. These benefits may differ based on the goals and conditions of the organization, but they highlight the reasons why a lot of businesses go this route:

2. First, by offering shares to the general public, businesses can raise money through an IPO. This cash infusion can be put to a variety of uses, including funding operations expansion, debt repayment, research and development investments, and growth efforts. Companies are able to obtain the capital required to support their goals when they have access to a larger pool of investors.

3. Going public through an Initial Public Offering (IPO) offers several alluring benefits for companies and their stakeholders. These advantages might vary depending on the objectives and circumstances of the company, but they illustrate the main arguments for why many companies choose this course of action:

4. First, companies can raise capital through an IPO by making shares available to the general public. This capital infusion can be used for a number of things, such as growth initiatives, debt reduction, operations expansion, and expenditures in research and development. When businesses have access to a bigger pool of investors, they can raise the money needed to support their objectives.

5. An initial public offering (IPO) can also help attract and retain top talent. Offering stock-based compensation packages makes it easier for publicly traded companies to attract and keep outstanding talent. Potential stock price growth and the chance to become shareholders, which aligns their interests with the company's long-term performance, are common motivators for employees.

 

2. SECONDARY PUBLIC OFFERINGS

 

A secondary offering is the process by which an investor sells their shares to the general public. The equities that the corporation is offering in the IPO are the ones that it previously sold. The stockholders who sell their shares instead of the corporation receive the earnings from a secondary offering.

 

HOW DO SECONDARY OFFERINGS WORK?

 

1. An IPO is a method that private businesses can use to sell investors shares in order to raise money. An IPO is, as the name suggests, the first time a firm makes shares available to the general public. On the primary market, investors are offered these brand-new securities for purchase. The company may choose to make acquisitions using the revenues, fund ongoing operations, or use them for other uses.

2. Investors may choose to make secondary offers to the public on the secondary market or the stock market following the completion of the IPO. As previously stated, investors hold the securities sold in a secondary offering, which they then sell to one or more other investors via a stock exchange. Because of this, the seller receives the full revenues from a secondary offering rather than the business whose shares are exchanged.

3. A business may occasionally do a follow-on offering, also known as a secondary offering. It can become necessary to raise money in order to pay off debt, support future investments, or finance its R&D pipeline.

4. In other situations, investors might notify the business that they want to sell their investments, and other businesses might make follow-on offers to customers looking to refinance debt at a discount to current interest rates.

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TYPES OF SECONDARY OFFERINGS

 

• Non-Dilutive Secondary Offerings

 

Since no new shares are usually generated in a non-dilutive secondary offering, existing shareholders are not affected by any diluting effects. It might not be advantageous to the issuing firm for private shareholders, like directors or other insiders, to sell their shares in order to diversify their holdings.

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This may increase trading liquidity for the issuing company's shares by enabling more institutions to take non-trivial stakes in the business. This secondary offering is usually carried out following an IPO, following the conclusion of the lock-up period.

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• Dilutive Secondary Offerings

 

A diluted secondary offering is referred to as a subsequent offering, or follow-on public offering (FPO). A company's current stock gets diluted when it issues additional shares to the market. The offering requires the board of directors' approval to raise the share float.

 

Earnings per share (EPS) declines with an increase in the number of outstanding shares. The corporation uses the cash flow to support expansion, pay off debt, or accomplish long-term objectives. This might not help investors with short-term goals.

 

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PRACTICE QUESTIONS

 

1. What is the primary purpose for a company to conduct an Initial Public Offering (IPO)?

a) To increase liquidity and raise capital

b) To boost company image and increase publicity

c) To motivate employees through stock-based compensation

d) All of the above

 

2. Which of the following is NOT a key role played by investment banks in the IPO process?

a) Advising on valuation and compliance

b) Marketing the IPO to potential investors

c) Determining the final IPO share price

d) Directly purchasing the IPO shares

 

3. Which of the following is a key step in the IPO process after the company decides to go public?

a) Engaging underwriters to manage the offering

b) Conducting a roadshow to market the IPO

c) Filing a registration statement with the SEC

d) All of the above

 

4. What is the primary risk associated with investing in IPOs for individual investors?

a) Shares may be primarily allocated to institutional investors

b) The company may not succeed after going public

c) IPO shares are subject to a lock-up period

d) All of the above

 

5. How can an IPO facilitate mergers and acquisitions activities for a publicly traded company?

a) By providing an exit strategy for founders and early investors

b) By allowing the company to use its publicly traded shares as acquisition currency

c) By boosting the company's image and credibility in the market

d) Both b and c

 

6. Which of the following is NOT a potential benefit of an IPO for a company's employees?

a) Ability to offer stock-based compensation to attract and retain talent

b) Increased liquidity for employee-owned shares

c) Improved public profile and brand recognition

d) Reduced dividend payouts to shareholders

 

7. What is the key difference between a fixed-price IPO and a book-building IPO?

a) In a fixed-price IPO, the share price is determined beforehand, while in book-building, it is determined through a bidding process.

b) Fixed-price IPOs are more common in the US, while book-building IPOs are more common in Europe.

c) Fixed-price IPOs have lower underwriting fees compared to book-building IPOs.

d) Both a and b

 

8. Which of the following is NOT a typical consideration for investors when evaluating whether to participate in an IPO?

a) The company's financial performance and growth potential

b) The reputation and track record of the underwriting investment bank

c) The level of institutional investor participation in the IPO

d) The company's dividend payout policy

 

9. What is the primary benefit of a "rights offering" for existing shareholders of a publicly traded company?

a) It allows them to maintain their proportional ownership in the company.

b) It provides them with an opportunity to invest in the company at a discounted price.

c) It reduces the dilution of their ownership stake.

d) Both a and b

 

10. What is the key advantage of "shelf registration" for a company conducting a secondary public offering?

a) It saves time on the offering process.

b) It eliminates the need for filing fees.

c) It allows the company to determine which investment bank offers the best service.

d) Both a and c

ANSWERS:

 

1. D

2. D

3. D

4. B

5. D

6. D

7. A

8. D

9. D

10. D

 

References:

 

Public Offering: Definition, Types, SEC Rules. (n.d.). Investopedia. https://www.investopedia.com/terms/p/publicoffering.asp#:~:text=Initial%20public%20offerings%20(IPOs)%20occur

 

Kagan, J. (2020, December 28). Learn About Secondary Offering. Investopedia. https://www.investopedia.com/terms/s/secondaryoffering.asp

 

What Is a Secondary Offering? (2024, April 8). SoFi. https://www.sofi.com/learn/content/what-is-a-secondary-offering/

What is an Initial Public Offering (IPO) & How Does it Work? (n.d.). Www.tastylive.com. https://www.tastylive.com/concepts-strategies/ipo