When you first start investing, it’s easy to get caught up in the exciting world of stocks, bonds, and other assets suddenly at your feet. But in the midst of the ensuing exploration and debate – should I invest in Amazon or Shopify? Pfizer or Moderna? – have you ever stopped to wonder why there are some companies you can’t buy?
Any corporation available on an exchange is a public company, which broadly means that the general public can trade their stock. On the other hand, private companies are held by insiders – founders, employees, family and friends, and early investors. So how does a company go about becoming public and listing on an exchange?
The answer is with a public offering.
An IPO, or initial public offering, is the process whereby a private company offers stock to the public at large. Before their IPO, a company is still considered private, and funds flow in from a relatively small pool of investors. As a private entity, companies often focus on defining their mission, building name recognition, and growing their customer base.
But when a company reaches the stage where founders believe it can adhere to SEC regulations, as well as the expectations of and legal obligations to public shareholders, it can file its intentions to go public.
Filing for an IPO signals significant changes ahead, and it’s not a short process by any means. While there are tons of nuances to navigate, there are five major milestones that every hopeful entity must hit for a successful IPO.
Underwriting typically occurs six or more months before the IPO itself. The underwriter is crucial to an IPO’s success, as it’s their job to ensure that shares are sold at the set price.
The process kicks off after the issuing company announces its intention to go public. At this point, banks and other institutions can submit bids to handle the proceedings. These bids detail fees (up to 7% of the IPO total sales) and how much the IPO will raise.
Then, the company can select the best applicant based on price, reputation, and expertise. Typically, the issuing entity looks for a bank that will drum up the most business, as it’s the bank’s responsibility to gather initial buyers.
Once the company selects a bank, the two institutions enter an agreement that outlines important details, such as:
This process occurs at least three months before the IPO. During this time, an IPO team consisting of the lead investment banker, lawyers, accountants, SEC experts, and others assembles to hash out the details of the IPO. Typical considerations under this team’s purview include:
Once the appropriate arrangements have been made, the IPO team files an S-1 registration statement with the SEC detailing information about the company and upcoming offering. It also details how the initial funds will be used, among myriad other details.
At this point, the SEC will investigate the company to ensure that all its ducks are in a row. If the issuing institution passes muster, the next step for the IPO team is to set a date and price the new company.
To do so, the underwriter puts together a prospectus of the hopeful company to circulate among prospective buyers. The company’s top executives can then present this data to institutions to drum up business – this is known as the “road show.” During this time, investors can submit bids for how many shares they would like to buy. The underwriter then takes investor interest into consideration when determining a prime IPO price.
In the months before the IPO, the new Board of Directors will meet to review an audit of the company’s current situation. The company will also file with its intended stock exchange(s) to list its IPO. However, bidding investors don’t learn how many shares they can buy until the day before the IPO.
This step occurs immediately after the IPO, but it’s still an important one. In the days following initial trading, the underwriter will ensure a continuing market for the stock. The goal is to keep interest high enough that the stock doesn’t fluctuate too wildly. This “quiet period” only lasts for 25 days and serves as the hand-off to the last phase of the IPO process.
25 days after the company’s IPO, the quiet period ends. The underwriter is then tasked with providing estimates about earnings, which helps investors “transition” to relying on mandated public information about the company.
Public offerings are an exciting (and busy) time for a company, and they provide investors with a chance to get in on the ground floor. But for most people itching to hop aboard, it’s best to wait a few weeks – or even months – for the hubbub to die down.
As a class, IPO securities are not designed to perform well relative to the current market. Rather, they’re priced at a premium to rake in the most capital possible. (The same may not necessarily be true of a DPO, though investors should still watch for signs of overpriced securities.)
Furthermore, many advanced investors use IPOs as a chance to speculate in the market, which can increase early volatility and drive prices into overvaluation territory. While many IPOs experience a surge in the first day or two, the bottom often drops out as interest wanes, which leads to unfortunate – and in many cases, unnecessary – losses.
But if you’ve considered your options and decided that IPO investing is for you, be sure to evaluate the company from multiple angles. Consider:
But most importantly, you want to make sure that the business is foundationally and fundamentally strong. Otherwise, you’re setting yourself up for future disappointments – not to mention losses.
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