What is an IPO?

An initial public offering (IPO) is the process by which a private company “goes public” and sells new shares on the stock market. An IPO allows a company to unlock new growth and raise capital from public investors as well as provide private investors with the opportunity to exit their investment and realize a profit.

Before undergoing an IPO, a company must go through an extensive IPO process, including meeting certain requirements as set by the Securities and Exchange Commission (SEC).

In our infographic below, we’ll outline the steps involved in the IPO process at a high level and then dive deeper into frequently asked questions for a more comprehensive look.

What are the alternatives to a traditional IPO?

In recent years, more companies are choosing to forgo the IPO route. Instead, opting for alternative methods to listing on the public market.


Direct listing vs IPO

In a direct listing (also known as a direct public offering), a private company will go public by selling shares to investors on the stock exchanges without an IPO. Direct listings eliminate the need for an IPO roadshow or IPO underwriter, which saves the company time and money. Historically, this method has been used primarily by budget-conscious small businesses seeking to avoid the abundance of fees associated with traditional IPOs.

Additionally, direct listings give shareholders the opportunity to sell their stake in the company as soon as it goes public, without experiencing the holding period they normally would with an IPO. This can also help avoid the dilution that issuing new shares could cause. We explore the differences between a direct listing and an IPO in more depth in another article.


SPAC vs IPO

A special purpose acquisition company (SPAC) is a publicly-traded buyout company that raises capital through an IPO in order to purchase or gain a controlling stake in a company. When a company gets acquired by a SPAC, it goes public without paying for an IPO because all fees and underwriting costs are covered before the target company ever gets involved.

When the coronavirus pandemic rattled many IPO plans, SPACs kept going public. One reason is that a SPAC's value is tied to how much it raised from investors, so it's less susceptible to the ups and downs of the market. We explore the differences between SPACs, traditional IPOs and direct listings in another article.

Traditional IPO vs SPAC vs DPO

Traditional IPO

  • Process by which a private company goes public
  • Offers new shares to the public
  • Raises new capital from public investors
  • Requires an IPO roadshow and underwriters, which can be costly

SPAC

  • Is a publicly traded buyout company
  • Raises capital via IPO
  • Looks to buy a private company that fits investment strategy
  • Buys private company, which then goes public without paying for IPO

Direct listing or DPO

  • Process by which a private company goes public
  • Sells shares directly to the public without intermediaries
  • Eliminates need for an IPO roadshow, investment banks or underwriters
  • No lock-up or holding periods for investors

Quick FAQ on the IPO process

How long does it take to complete the IPO process?

The IPO process is complex and the amount of time it takes depends on many factors. If the team managing the IPO is well organized, then it will typically take six to nine months for the company to complete its public debut. The transition from private to public is a demanding process and incurs a lot of expenses for the issuing company.

What is an underwriter and how do you choose one to work with?

An IPO underwriter is synonymous with the investment bank providing the underwriting service. Underwriters lead the IPO process and are chosen by the company, which could decide to hire a team of underwriters to manage different parts of the IPO.

The success of an IPO relies heavily on choosing the right underwriter. Companies will look at a firm’s reputation, their quality of research and industry expertise when considering investment banks to work with. After choosing an IPO underwriter, the two parties will formally agree to terms through an underwriting agreement. This includes the amount of capital the underwriter receives during the IPO, which is typically between five and eight percent.

Who is a part of the IPO team?

The IPO team consists of executives at the issuing company, underwriters, lawyers, certified public accountants (CPAs) and Securities and Exchange Commission (SEC) experts. This team is responsible for taking the company through the IPO process, handling the complex transition from private to public and every important decision that accompanies the journey.

What is IPO due diligence?

Due diligence is a standard process for any investment workflow. For IPOs, it is an investigation into the private company’s financials and the potential risk factors of going public. During this workflow, the company and IPO underwriters will fill out the required paperwork. The issuing company will also register with the SEC.

What documents have to be filled out for the IPO process?

Companies are required to fill out and submit several pieces of documentation, including financial statements, throughout the IPO journey. Here’s a quick overview of each:

Agreeing to terms with underwriter and issuing company:  
  • Firm commitment: States the underwriter will purchase all shares from the issuing company and resell them to the public.
  • Best efforts agreement: States the underwriter will not guarantee a specific amount of money but will sell the share on behalf of the company.
  • Syndicate of underwriters: An alliance between a group of investment banks to sell part of the IPO, which diversifies the risk.
The underwriter will draft:  
  • Engagement letter: Includes reimbursement clause, which holds the issuing company accountable to covering the underwriter’s out-of-pocket expenses. Also includes the gross spread, also known as the underwriting discount, which is intended to cover the underwriter’s fee.
  • Letter of intent: States underwriters commitment to the company and the company’s agreement to cooperate, provide all information, and offer the underwriter a 15% overallotment option.
  • Red Herring document: A preliminary prospectus that has information on the company’s operations, but doesn’t include share price or number of shares.
Required documentation by the SEC:  
  • S-1 registration statement: The primary document for filing the IPO. It is made up of two parts: The prospectus and private information that is not required to be disclosed to investors, but must be reported to the SEC. It also includes the expected IPO date. In essence, the S-1 filing is the first peek into the financial underbelly of a company.

 

What is an IPO roadshow?

The IPO roadshow is a company’s chance to market and drum up interest for shares. It is also a way to gauge demand for shares, helping the underwriters navigate the IPO process. Traditionally, the company and underwriters travel to different locations—however, digital roadshows became the norm during the COVID-19 pandemic and have the potential to become the standard moving forward.

How are IPOs valued and priced?

Pricing and valuing an IPO depends on many factors, not just the company itself. Market conditions and demand also play a strong role in the valuation. There are a couple intrinsic and relative valuation methods that are used to value a company:

  • Discounted cash flow analysis, an intrinsic valuation method that looks at the value of an investment based on its projected future cash flows.
  • Comparable public company analysis, a relative valuation method that compares publicly traded companies operating in a similar sector and location to the valuation company, usually with similar levels of revenue and market capitalization.
  • Precedent translation or private comparable analysis, a relative valuation method that looks at historical prices for completed deals within the private markets that involve similar companies.

More on public listings in VC and PE

The strengthening IPO market
Listen to In Visible Capital podcast: VC's resurgence, the IPO boom and what's in store for 2021

Why companies valued $5B+ may choose direct listings
Read PitchBook Analyst Note: Consumer Unicorns Make Moves for 2021 Direct Listings

Why SPAC IPO activity is here to stay
Read PitchBook Analyst Note: SPAC Market Update: Q1 2021 
 

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