An Initial Public Offering or IPO, is the initial sale of a private company’s stock to the public before it lists on the stock exchange. Used primarily as a vehicle to raise capital by offering shares to the public, an IPO funds are used for company acquisitions, debt repayment and/or working capital for business expansions. Through the IPO process, also referred to as ‘going public’ or a ‘float’ – the status of a privately held company changes to a public company – and the number of shareholders increases to include the public who otherwise would not be able to invest in the company. Following an IPO, the company is listed on the stock exchange and shares can be traded on the secondary market.show more
The IPO process is both complex and lengthy.
Working closely with underwriters – typically an investment bank who is tasked with the responsibility of completing the IPO process – the company, in preparation for an IPO must prepare a prospectus (an offer document), participate in the due diligence process, value the shares and market the shares to the public.
The prospectus is a disclosure document detailing particulars of the proposed offer. The prospectus lists the opportunities, risks and financial details about the company as well as the number of shares to be issued in the IPO and the offering price.
Due diligence involves review of the company’s legal, financial, business and accounting status. Often considered the most important and time-consuming process of the IPO, the company’s business and marketing plans, revenue projections, product development road map and intellectual property protections are all reviewed. Company officers as well as key employees, customers, retailers and suppliers are also examined during the due diligence phase in an effort to identify potential opportunities and threats.
The price of the shares offered in the IPO are valued according to number of shares and the percentage of the company included in the offer. The amount of capital needing to be raised by the IPO also factors into price valuation.
Although companies with transferable shares date back to classical Rome, the first modern era IPO occurred in 1602 when the Dutch East India Company (VOC) offered its shares to the public in a capital raising exercise. VOC was also the first company to list its shares on an official secondary market stock exchange – the Amsterdam Stock Exchange. While the Bank of North America was the first public offering IPO in the United States (1783), Alibaba Group’s huge IPO of $25 billion broke records as the largest IPO in history after pricing its offering at $68 per share on Sept. 18, 2014.
The primary market – also known as the new issues market – is where an IPO takes place. Conducted directly between the issuer and the buyer through an underwriter intermediary, primary market transactions are offered at a fixed price to raise funds for long term capital requirements. An IPO is a public issue in which a privately held company converts into a public company.
Following an IPO, shares trade between buyers and sellers on the open secondary market.
A company’s IPO offering price – also known as the IPO price – is the price at which a company sells its shares to investors in the primary market.
The IPO opening price is the price at which those share begin to trade on the open secondary market.
The difference between the offering and the opening price is typically based on supply and demand – that is, the size of the float (representing supply) and the price valuation (representing demand).
Although listing on a company’s home exchange is preferred, the stock exchange chosen for the company’s IPO listing is also critical to price. The exchange may be selected based on the exchange’s prominence, investor base, listing costs, regulatory requirements, technology, performance and/or target market. In terms of value, the Stock Exchange of Hong Kong (HKEx) was the top IPO fundraising exchange in 2016 raising HK$194.8 billion. The Shanghai Stock Exchange and New York Stock Exchange (NYSE) ranked second and third with IPO funds raised of US$16.3 billion and US$14.7 billion, respectively.
Not to be confused with market value which is an amount assigned when a company is sold, market capitalisation – referred to as market cap – is a reference to a company’s size (small cap, mid cap or large cap). Market capitalisation prior to an IPO is computed by calculating the number of common shares outstanding plus the number of preferred shares which convert into common upon the IPO plus the number of shares sold in the offering multiplied by the IPO stock price.
Market capitalisation post IPO is calculated using the stocks price multiplied by the total number of shares outstanding – that is, the theoretical cost of buying all of the company’s shares.
EXAMPLE: If a company has a share price of $0.50, and 10,000,000 shares outstanding, its market capitalization would be $5,000,000.
Any percentage change in the stock’s price will equal a percentage change in the company’s value.
A ‘stag’ is an investor or speculator who buys fixed priced shares in a new issue (such as an IPO) with the expectation the price of the shares will rise immediately upon listing as a result of an oversubscription for the shares or simply – that demand for the new shares exceeds supply leading to an increase in the share price. A stag – also referred to as a ‘flipper’ – will then sell the shares quickly in order to realise a trading profit.
A ‘stag profit’ is the financial gain achieved from the value of the shares rising in value.
An IPO is oversubscribed when demand for the shares is greater than the number of shares being issued. Also referred to as ‘overbooking’ and typically expressed as a multiple, when an IPO is oversubscribed, price has a greater likelihood of opening higher in the secondary market than its IPO offering price. (NOTE: when an IPO is oversubscribed, underwriters have the opportunity to adjust the offer price to reflect higher than expected demand).
EXAMPLE: If an IPO is oversubscribed three times, demand is three times the number of shares that will be issued.
An IPO is undersubscribed when demand for the share is less than the number of shares being issued. Also referred to as ‘underbooking’, when an IPO is undersubscribed – price has a greater likelihood of opening lower in the secondary market than its IPO offering price. An undersubscribed IPO often relates to overpricing the offering price.