The Initial Public Offering

Top

Newsletter Sign Up

Home >> Public Company Topics

The Initial Public Offering (IPO)

The basic steps in the initial public offering process are due diligence investigations of a company’s operations and finances, followed by the creation of a registration statement, whose contents are then updated based on SEC comments. This is followed by a road show, final pricing of the stock, filing of the final prospectus with the SEC, and then closing the deal with the underwriter. The following discussion is based on a firm commitment deal with an underwriter.

Due Diligence

The due diligence process is conducted by the underwriter. It requires outside auditors to comb the company’s financial records at a level of detail significantly greater than a standard audit, and then issue a comfort letter to the underwriter, stating the additional procedures it completed at the request of the underwriter. These procedures usually relate to unaudited financial information that is included in the registration statement. The auditors send the comfort letter to the underwriter once the initial registration statement has been filed.

The Registration Statement

The registration statement is comprised of a prospectus and additional information required by the SEC. The statement is the SEC’s Form S-1. The prospectus portion of the statement is an overview of the company’s operations and finances, and is carefully designed to be a balance of marketing language intended to bolster the stock and a tedious itemization of every conceivable risk to which the company is or may be subject, with the intent of avoiding liability in case the company’s prospects sour after it goes public. It also includes all standard financial reports.

The registration statement is then forwarded to the SEC, which usually takesone month to review it, after which it issues a comment letter, which contains required changes that must be added to the statement in order to bring it into compliance with SEC regulations. Once these changes are made in an amended filing, the SEC has the right to continue reviewing the document until it declares the statement to be effective.

The prospectus portion of the registration statement is then sent to prospective investors. This red herring version of the statement may not yet have been approved by the SEC, and will not include a final stock price, but will list a range within which the final price will fall. This version is used to educate investors in advance about the offering, but is not used to solicit the sale of stock. It is also sent to the syndicate of other underwriters that the primary, or “managing” underwriter will assemble to help sell the stock.

The Road Show

After filing the registration statement and prior to its effective date, the company's senior management team goes on a road show to visit a number of key institutional investors and analysts, where they make a sales pitch about the company, but do not attempt to sell any shares. The SEC also permits road shows over the Internet, which can be a great time savings for the management team.

The Stock Exchange Application

While the management team is conducting the road show, its legal counsel files an application with the stock exchange on which it wishes to be listed, while also selecting a registrar (who tracks all stock, pays out dividends of various types, and mails reports to shareholders) and a stock transfer agent (who handles the transfer of shares between parties) to handle subsequent stock-related issues. It will also submit filings in accordance with the securities laws of all states in which the company expects to sell shares.

Setting the Stock Price

Once the SEC is satisfied with all changes made to the registration statement, company management meets with the underwriter to set the final price of the stock. The comments of institutional investors who were contacted during the road show will have a strong bearing on the final price. They are usually relied upon to purchase a significant proportion of the company’s stock, and if they show resistance to purchasing stock at a specific price, then the underwriter will recommend a price reduction. In addition, the underwriter will underprice the issuance slightly in order to ensure a complete sale of all shares offered to the public, while also giving it some grounds for avoiding a lawsuit in case the stock price later declines, and investors claim that the initial price was too high.

Declaring the Registration Effective

Once all parties agree to the stock price, this is included in the registration statement as an amendment, along with the net proceeds by the company resulting from the offering, and the underwriter’s commission. The company then asks the SEC to declare the registration statement effective. This request is typically accompanied by a request to accelerate the SEC’s standard 20-day waiting period between the filing date of the last amendment and the date when the registration is declared effective, which the SEC generally agrees to as long as the prospectus has already been sufficiently widely circulated to prospective investors in its “red herring” format. After the registration is declared effective, the company issues the prospectus to the investors who previously received the “red herring,” as well as any others who wish to review it.

Prospectus Updates

During the post-effective period, the company must update the prospectus for any material events or change in earnings. These updates can be made by affixing stickers to the prospectus that contain the updated information. This saves the company the expense of reprinting the entire prospectus.

Final Payment

Finally, at a closing meeting that usually takes place one week after the registration effective date, the underwriter hands over payment for all shares proffered under the IPO offering in exchange for the share certificates. This delay of a few days is needed for the underwriter to collect cash from its investors, who will then receive the stock from the underwriter. The company is now officially a public entity.