How a Private Share Becomes a Public Stock & Some Tips about Buying a Newly Traded Stock
Nationally and locally, there has been a lot about IPOs, what with the long awaited Facebook IPO, and our very own local Synacor. Many people I’ve been talking to about these ventures do not really understand the “whys, hows, and wha fors” of an IPO. So I thought I would explain the process and some tips on buying a company that recently has gone public.
For starters- an IPO is an acronym for Initial Public Offering. It refers to the event in which a private company sells its shares to the public for the first time. A company may decide to go public for many reasons. They may need the equity from public investing in order to continue to grow, or the investors of the company may want to sell their shares to the public to recover their initial investments. Regulation becomes a factor as well; for example, Facebook had too many private investors not to be regulated under the Security and Exchange Commission (SEC) and therefore had to “go public”.
If a company decides to go public, they need to prepare for a couple of years before the IPO. A public company’s finances are scrutinized both by the SEC and the investment firms that may be interested in buying that company’s stock. The company should show continuous growth, strong management, and a conservative amount of debt. This makes the investment look valuable to a potential investor. Usually a company hires an investment firm to manage the process before the IPO.
Once the company has completed this process, the company picks an IPO team that usually consists of a major accounting firm, a legal counsel and an investment bank that will initiate the IPO. The three entities meet with the company, and then discuss and distribute tasks at an initiation meeting called the “all hands” meeting.
The second and most daunting task of a company during the IPO process is creating the prospectus (if you own any investment, you have seen one of these. They are printed on very thin paper with very small type). The prospectus is important because it is an advertisement/manual created for the investors to look at to determine whether or not they would like to buy that company’s stock. This is critical because the SEC commands a “quiet period” after the company files the IPO. The company is prohibited from advertising to the investors. The prospectus is the only advertising tool the company will have to entice these investors. Once a rough draft of the prospectus is done, it must be filed with the SEC and the SEC will audit it, make changes and verify its accuracy.
Once the prospectus is approved by the SEC, the main investment bank has to gather other investment banks that will help to sell the company’s shares. This leads to the creation of the Syndicate.
As with any new product that is going on the market, the next step is to go to a convention so prospective buyers can be informed about the product. This is called a Road Show. The Road Show stops in a few major cities so the investors can get familiar with the company.
After the company finishes their Road Show, the investment bank uses the share value of the company, along with the potential growth of the company, the result of how well the company did on the Road Show, how much “buzz” the company is getting from large investment companies (along with many other metrics) to determine a price for the stock.
After the price is determined, the stock goes to trade and IPO day has arrived. The head investment firm is responsible for making sure the IPO goes smoothly and is allowed to support the stock by investing in it to keep the predicted price of the stock stable for the first couple of days of trading.
And that’s how a private share becomes a public stock!
I tend to invest in the IPO’s of companies I love!! The last IPO I invested in was Tim Horton’s. I have a strong emotional connection to Tim Horton’s and therefore I wanted to show my support in that company. However, IPOs are very risky. Here are some things you should keep in mind before buying an IPO.
1. The company has no experience in being a public company. Although going public creates a lot of opportunities for a company, it still is a complicated process. The company is regulated by the SEC for the first time. The SEC’s regulations are both expensive and difficult to uphold.
2. The company’s sole responsibility is to please the shareholders/investors which may change the infrastructure, management or even the product of the company.
3. The SEC instates a “lock-out” period, which means the owners and employees of the company that own shares are not allowed to sell their shares for 90-180 days after the IPO. So the stock will usually go down after the lock-out period ends because the owners may need to sell and diversify there portfolios.
