Initial Public Offering: Procedure, Pros and Cons

Initial public offerings are an opportunity for private businesses to raise capital. They have their pros and cons, follow a strict procedure and are subject to numerous legal requirements. Read on to find out more and contact us if you need further assistance.

What is an IPO or initial public offering?

Initial public offering (IPO) is the process of transforming a privately held business into a public company. This is done by selling its shares on the stock exchange to individual or institutional investors.

IPOs, also called stock market launches, allow private companies to raise capital from public investors. Going public can also be an opportunity for the founders of the company or its private equity investors to monetize their investment. They do this by selling all or part of their stock in the company on the public market.

In order to qualify for an IPO, a company must meet certain requirements set by exchanges. They must also comply with certain laws. The governing body reviewing and approving listings in the UK is the Financial Conduct Authority (FCA). In the USA this role is played by the Securities and Exchange Commission (SEC).

Companies typically hire investment banks to underwrite the IPO, determine the share price and set the IPO date. Investment bankers also gauge demand and even market the public offering, so they support the company throughout the whole IPO process.

IPO Procedure: How does an initial public offering work?

The IPO process involves two main phases: a pre-marketing phase and the IPO stage. The procedure includes the following basic steps:

1. Selecting and contracting underwriters for the IPO
2. Pre-IPO due diligence
3. Pricing of IPO shares
4. Initial public offering
5. Quiet period

Are you ready for an IPO?

Before venturing into an IPO, a private company needs to consider that this growth opportunity involves:

• Proving its financial stability (in compliance with IPO accounting standards);
• Proving its potential for profitability;
• Developing a professional management team;
• Creating a defence against takeovers.

In the USA companies are considered to be ready for an IPO when they’ve reached the so-called Unicorn status, i.e. a valuation of approximately $1 billion. However, IPOs can occur at different valuations. What is important is that all of them follow a strict procedure.

The IPO process

1. Select and contract investment banks - the underwriters for the IPO.

The private company approaches a number of banks regarding the IPO. These potential underwriters provide proposals, detailing the type of security, number of shares, offering price, marketing time-frame and bank fees.

The company typically chooses its underwriters based on proposed conditions, bank’s reputation and expertise in the company’s industry. 

The lead underwriter among these sells the shares of the company to the public. The bank selects buyers so as to diversify risk. The underwriter fee is a percentage of the share sale proceeds (typically ranging from 3% to 7%).

The next step is entering into contract with the selected underwriters. Due to the large number of legal requirements, legal experts play an important role here. If you need expert support in an IPO, contact us.

2. Due diligence

Once the underwriters have been contracted, an IPO team is formed. It includes representatives of the underwriters, corporate lawyers, accountants, exchange commission experts, and public relations specialists.

The team has a number of due diligence responsibilities, including:

• assembling the necessary financial information;
• identifying and selling-off any unprofitable company assets;
• improving cash flow;
• selecting a new management team, if necessary;
• filing documents necessary for the IPO.

These preliminary IPO documents provide information about the company itself and the IPO filing. In the USA this is the so-called S-1 Registration Statement.

Generally, the required documents include financial statements, information related to the business model and management of the company, etc. These are then verified by the relevant IPO authorities (FCA in the UK or SEC in the USA).

If you need a trusted legal partner for the Due diligence procedure of your IPO, contact Danailova, Todorov and partners.

3. Pricing of IPO shares

The IPO team also prepares a marketing strategy and materials that are sent out to prospective buyers. This helps estimate the demand for the IPO shares and determine a final offering share price. This may lead to a change in the share price and IPO date stated and therefore - a revised prospectus.

Once this IPO documentation is approved by authorities, an IPO date is set. The company then joins the stock exchange and lists the IPO.

4. Initial Public Offering

On the IPO date the private company issues shares.

The New York Stock Exchange has a ritual where CEO and investors can ring the bell on the morning of the IPO. Chinese IPOs are celebrated with a gong (and a virtual version in virus times).

Once the sales have started, the company receives capital as cash. This is recorded as stockholders equity on its balance sheet.

Underwriters make sure there are enough buyers after the initial public offering to keep the stock price stable.

5. Post-IPO provisions

In certain cases, a specific period may be determined when the underwriter would be allowed to buy additional shares after the IPO. Also a quiet period may be established for certain investors to avoid the appearance of insider information. Under US regulations, for example,  this quiet period starts with the filing of the registration paperwork and ends 40 days after the stock has started trading.

Typically, underwriters look for large institutional investors to buy large lots during the IPO. Individual investors usually buy stocks when they start trading on the secondary market (The London Stock Exchanges, NYSE, etc.).

What are the benefits of an IPO?

An IPO has a number of advantages  for a growing private company as an opportunity to:

• raise capital - by providing access to investment capital from the entire public;
• access borrowing - due to the rigors of quarterly reporting and the resulting transparency (easier access may be also paired with better conditions);
• attract new talent  - often management or skilled professionals are offered stock compensation;
• increase investment value - for the original private investors;
• raise additional funds - whenever necessary, after the IPO, the company can use secondary offering of shares on the public market to raise extra cash.

What are the disadvantages of an IPO?

Although it is a growing opportunity, an IPO has a few cons too, such as:

• IPO expenses - the IPO process itself is expensive. There are also additional ongoing costs related to quarterly reporting and the necessary legal, accounting talent.
• disclosing information - publicly traded companies are required to report quarterly. Therefore they disclose financial, tax, accounting and other business information, which may be used by competitors.
• less control - the new public company is controlled by a Board of directors. This may mean less control over decision making for original company founders and investors.
• fluctuation in share price - these changes may decrease stability and affect management decisions.

Alternatives to IPOs

Although IPOs typically involve underwriters, private companies can choose alternative solutions.

A company with a well-known brand may go for a direct listing, i.e. an IPO without underwriters. This involves a greater risk for the issuer in case the offering does not do well. On the other hand, it has the benefit of a higher share price.

The Dutch auction is an IPO where the price is not determined. Bidders offer the price they are willing to pay. The highest bidders are allocated the shares.

IPO legal matters

Going public has its pros and cons, but is generally considered a wonderful opportunity to raise capital to fund expansion or acquisition. If you need assistance with Due Diligence or any IPO matters, simply contact our law firm in Bulgaria.

“Danailova, Todorov and Partners” Law Firm provides top-quality legal services on all aspects of trade law, contractual law, employment law, administrative law and tax law. We are a partner you can rely on.