What is Offering shares (IPO).?
Offering shares (IPO) is the process by which a company sells its shares to investors in exchange for money. The price of the shares is typically determined through a process called bookbuilding, in which investment banks gather orders from potential investors and then set the price based on the level of demand.
We hear a lot about the endless ease in the process of offering ownership of a company (whether American or foreign) in the American markets, and we hear a lot about the astronomical amounts of money that result from this process, and we wonder is it possible to divide the ownership of a small and unknown company into millions of shares and sell them in the financial market for such a price. These amounts? The answer is very short: Yes, but we must know the mechanics of this process, the motivations for doing it, and the extent of its profitability before we start thinking about entering into it as sellers or buyers. Table 1 shows the highest amount subscribed in the history of the US stock offering (until the end of 2001). Table 2 also shows the best closing price for the first day of the offering, which shows the extent of investor demand for these companies.
Table 1: Highest amounts raised through the IPO market
| Ranking | Company | Offering date | Amount subscribed (Million) |
|---|---|---|---|
| 1 | AT&T Wireless Group | 2000/4 AD | 10,620 |
| 2 | United Parcel Service | 1999/11 AD | 5,470 |
| 3 | Verizon Wireless | 2000/8 AD | 5,000 |
| 4 | Conoco | 1998/10 AD | 4,400 |
| 5 | The Goldman Sachs Group | 1999/5 AD | 3,660 |
Motives for the initial offering
A large percentage of companies begin their capitalist life with a simple idea generated in the mind of a scientist or professional, from which the person alone, or with the help of a friend with commercial inclinations, establishes a small workshop in the home of one of them, and then these two manufacture the product and sell it to those who have an interest in it. Upon noticing the high demand for the product, the two begin thinking about raising the capital of the workshop so that they can manufacture more of this successful product. However, due to the lack of money between them, other partners, friends and neighbors, usually enter the project, and this financing process develops until the company is officially registered with the competent authority in the country.
Table 2: The highest percentage increase in the share price on the first day of the offering.
| Ranking | Company | Offering date | Offering price | Closing price | Aspect ratio |
|---|---|---|---|---|---|
| 1 | VA Linux Systems, Inc. | 1999/12 AD | 30 | 239 | 698% |
| 2 | theglobe.com, inc. | 1998/10 AD | 9 | 63 | 606% |
| 3 | Foundry Networks, Inc. | 1999/9 AD | 25 | 156 | 525% |
| 4 | WebMethods, Inc. | 2000/2 AD | 35 | 213 | 508% |
| 5 | FreeMarkets, Inc. | 1999/12 AD | 48 | 280 | 483% |
After this registration process, this economic entity is transferred from an entity owned by one person (Sole Proprietorship) to the Limited Partnership. The partners soon discover that there is a larger market for their product. If they were able to pump more money into operation and sales, support the company’s marketing and development strength, and employ the necessary number of competent experts, the company would be able to compete for a larger portion of the product’s market share.
Then the partners ask about the benefits and drawbacks of floating the company’s shares, or offering them for public subscription, and it becomes clear that there are at least six main benefits to floating the company:
1. Limiting the liability of partners towards third parties, including lenders, banks, and others, because the liability of partners (or stockholders) is limited to the paid-up capital only, and whoever has a claim against the company must obtain his right from the company itself, not from its owners.
2. Pumping more money into operational, development and other functions, which is usually very difficult in the company's current situation as the partners may not have enough money or they do not want to risk more of their own money.
3. Increasing the wealth of partners by obtaining part of the paid-up capital, as a result of the shares they own, and there are many wealthy people who suddenly obtained their wealth by floating their company.
4. Diversifying investment methods for partners instead of relying on one company by investing their funds in other areas.
5. Creating a market for trading the company’s shares, which enables the partners to sell their shares easily and conveniently, instead of their current situation, which makes selling their shares in the company extremely difficult because
It provides a known price for the company, instead of the difficulty of convincing others to buy a share in an unknown company.
6. Making the company an independent entity that will not disappear due to the disappearance of some or even all of the owners. That is, the company is owned by certain people and managed by an administrative staff that does not necessarily have a relationship with the owners, whose ownership may be transferred from one person to another for various reasons.
In exchange for these good benefits of floating a company, there are some negatives:
1. There is the cost of registering the company and what must be paid in advance to the investment bank that handles the flotation process, which may sometimes reach 8% of the paid-up capital, and there are some other expenses related to this process, which may exceed half a million dollars when offering the equivalent of 10 million dollars in shares.
2. Public (i.e. joint stock) companies pay a higher rate of taxes than proprietary companies and companies with limited partners.
3. There is the issue of controlling the company with the presence of new investors who have the right to vote on the positions of board members and can replace those whose performance they are not satisfied with. Here, the partners may be forced to retain a 51% share of the company’s ownership in order to maintain their control over the company.
4. Because it is necessary for the public company to adhere to the principle of transparency in the financial accounts and development plans of the company, this constitutes an administrative burden on the company on the one hand, and on the other hand, it allows competing companies the possibility of identifying the company’s directions and knowing its financial results, which does not happen in the case of a limited company or Closed. Transparency may also rob partners of the right to maintain their financial privacy, as they must disclose everything they and their families own in the company.
5 Steps for the Initial Offering (IPO)
- Preparation: The company seeking to go public, known as the issuer, appoints an investment bank to act as its underwriter. The underwriter conducts due diligence on the company, assesses its financial health and growth prospects, and prepares a registration statement with the Securities and Exchange Commission (SEC).
- Registration Statement Filing: The registration statement, which includes detailed financial information, business plans, and risk factors, is filed with the SEC for review. The SEC reviews the registration statement to ensure it complies with disclosure requirements and protects investors.
- Roadshow and Pricing: During the roadshow, the issuer and its underwriters meet with potential investors, institutional and retail, to gauge interest in the IPO and gather feedback. Based on the feedback and market conditions, the underwriter determines the offering price range for the shares.
- IPO Launch: The IPO is officially launched when the final offering price is set within the specified range. Orders from investors are collected, and the underwriter allocates shares to meet the demand.
- Listing on Stock Exchange: Once the allocation process is complete, the shares begin trading on a major stock exchange, such as the New York Stock Exchange (NYSE) or Nasdaq. The company is now considered a publicly traded company.
How is the Price Determined?
The offering price of a company's shares is determined through a process called bookbuilding, which involves gathering orders from potential investors and analyzing the level of demand.
The investment banks, led by the underwriter, set the price based on several factors:
- Company's Financial Performance: Companies with strong financial performance, such as consistent profits and growth, typically command higher offering prices.
- Growth Prospects: Investors are willing to pay more for shares of companies with promising growth prospects, indicating future earnings potential.
- Market Conditions: The overall market sentiment and supply-demand dynamics in the IPO market influence the pricing strategy.
- Investor Demand: The level of interest expressed by potential investors during the roadshow and order-taking period plays a crucial role in determining the offering price.
How Can an Investor Obtain Initial Shares?
Investors can participate in an IPO through various methods:
- Retail Brokerage Accounts: Most brokerage firms allow retail investors to place orders for IPO shares during the bookbuilding process.
- Direct Participation Programs (DPPs): Companies may offer DPPs, which provide individual investors with a limited opportunity to directly purchase shares in the IPO.
- Mutual Funds and ETFs: Some mutual funds and ETFs specialize in investing in newly public companies, allowing investors to indirectly participate in IPOs.
Caveats for Investing in Primary Stocks
Investing in IPOs carries inherent risks, and investors should exercise caution:
- Price Volatility: IPO shares often experience significant price fluctuations in the immediate post-listing period due to high demand and uncertainty.
- Limited Trading History: Without a substantial trading history, it can be challenging to accurately assess a company's value and future performance.
- Lockup Periods: Insiders and early investors may have lockup periods, restricting their ability to sell shares immediately after the IPO, which can affect liquidity.
- Information Asymmetry: Access to relevant information about the company's financial health and future plans may be limited, making it difficult for investors to make informed decisions.
- Dilution of Ownership: New share issuance can dilute the ownership stake of existing shareholders.
alert
Avoid submitting a purchase order at the market price in the case of an initial offering, and in particular avoid submitting a purchase order before the market opens. There are many sad stories of cases in which purchases were made at a price equivalent to sometimes five to six times the offering price on the first day, and then the price fell to less than 50% within a day or two!