Question

a) Discuss the process of going public through an IPO. Your answer should also include the Part played by the underwriter in the issuance of the IPO.

Answer 1

The Initial Public Offering is a process where a previously unlisted company sells new or existing securities and offers them to the public for the first time.

IPO PROCESS

Below are the steps a company must undergo to go public via IPO :

Step 1. Select an Underwriter (Investment Bank)

The first step in a IPO process for an issuing company is to select an Underwriter to advice the company on its IPO and to provide underwriting services.

Step 2. Due Diligence and Regulatory Findings

This is certainly the most important step in IPO process. Underwriting is the process through which an investment bank acts as a broker between the issuing company and the investing public to help the company to sell its initial set of shares.

An underwriter must draft the following documents:

Engagement Letter: A letter of engagement typically includes:

1. Reimbursement clause
2. Gross spread/underwriting discount

Letter of Intent: A letter of intent typically contains the following information:

1. The underwriter’s commitment to enter an underwriting agreement with the issuing company
2. A commitment by the issuing company to provide the underwriter with all relevant information and thus, fully co-operate in all due diligence efforts.
3. An agreement by the issuing company to provide the underwriter with a 15% overallotment option.

Underwriting Agreement: The letter of intent remains in effect until the pricing of the securities, after which the Underwriting Agreement is executed.

Registration Statement: The registration statement consists of information regarding the IPO, the financial statements of the company, the background of the management, insider holdings, any legal problems faced by the company.

Red herring document: In the cooling-off period, the underwriter creates an initial prospectus which consists of the details of the issuing company, save the effective date and offer price.

Step 3: Pricing

On the day before the effective date, the issuing company and the underwriter decide the offer price i.e. the price at which the shares will be sold by the issuing company and the precise number of shares to be sold.

Step 4: Stabilization

The underwriter carries out after-market stabilization in the event of order imbalances by purchasing shares at the offering price or below it.

Stabilization activities can only be carried out for a short period of time,however, during this period of time, the underwriter has the freedom to trade and influence the price of the issue as prohibitions against price manipulation are suspended.

Step 5: Transition

The final stage of the IPO process, the transition to market competition, starts 25 days after the initial public offering, once the quiet period mandatedby the SEC ends.

During this period, investors transition from relying on the mandated disclosures and prospectus to relying on the market forces for information regarding their shares.