Question

Fred owns a sole proprietorship and decides to turn it into a corporation. He will take his company public to raise money. Explain all the steps Fred will need to go through to do this, including the steps of the initial public offering. Explain, Discuss.

Answer 1

The following can be the steps have to be taken in order to take company public -

1. Choosing an underwriter: These are investment banks that are registered with the SEC and are certified to perform underwriting services. These include estimating the initial offer price, buying the shares from the company and selling them to potential investors. These investment banks have a network of possible investors who are willing to invest. Hence, before choosing the underwriter, it is important to be able to gauge the network strength of the bank, its research quality and past performance.
2. Due Diligence: This is the most time consuming part of the process. This involves a lot of paper work, registering with the SEC and several contracts to be filed with the underwriter. This includes commitment from the underwriter to buy all the shares from the company, the underwriter guaranteeing "best efforts" and no specific sum of capital to be raised, the letter of engagement between the underwriter and the company, the letter of intent from the underwriter to the company, the "red herring" document or the priliminary prospectus of the company which it hopes to pitch to the investors, etc.
3. IPO Roadshow: The underwriter and the company then travel to reach out to various investors and pitch their company to them. This involves analysing the market demand and then modifying their pitch as well.
4. IPO Price: Once the SEC has given its approval, the underwriter and the company decides on the number of shares, the price and the issue date. This is the most important step of the process. IPO can be underpriced, since the investors will invest only if they know that the price will increase later.
5. Going Public: At the agreed upon date, the underwriter releases the shares to the public.
6. IPO stabilization: This is the period where the underwriters can increase the price of the shares. The underwriter has to ensure that there are enough buyers in the market to ensure the price of the shares is stable. They can go for the following options - Greenshoe option: This allows the underwriter to sell more than the agreed upon number of shares, if the price falls, they buy them back to increase the demand. They can also go for the Lock-up period: which prevents any insider who owned shares before they went public, from cashing out and selling their stock. This can be for a period of 90-180 days.
7. Transaition to market competition: This is the stage where the shares are now trading freely in the market. The underwriter has no further control on the process, and move from an active to an advisory role. The investors now look at the market price and not the prospectus anymore.