by Nicole Lee | 46 Comments

The Initial Public Offering (IPO) Process: Got

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' long time ago, initial public offeringswere the end
game for many technology startups( you coul# go pu"lic, get ac)uire#, or #ie a
spectacular #eath$
*r +ust mu##le along an# #ie a slower, more painful #eath$
'n# then one company came along an# change# all that$
,hile e!eryone has "een o"sessing o!er Face"ook-s I.* to#ay, the great irony is that
Face"ook itself has ma#e I.*s less releant than eer before$
/ere-s how the I.* process normally works when you-re at a "ank, an# what Face"ook
#i# to upen# most of that 0 an# make thousan#s of people !ery wealthy in the process(
!hat is an Initial Public Offering (IPO)?
It-s the first time that a pre!iously pri!ate company can sell its shares to 1the general
pu"lic2 3mostly institutional in!estors at first4$
5sually the company issues aroun# "#$%#& of its shares 3free float4, though this !aries
"y in#ustry, company stage, an# so on$
6ost in!estors consi#er it riskier if the company only makes a!aila"le a low num"er of
shares 0 "ut if the company is 1hot2 enough 3see( Face"ook, with its 778 offering4 they-ll
o!erlook this an# #i!e in hea#o!erheels anyway$
!h' Go Public?
9ou pro"a"ly associate I.*s with tech, healthcare, or "iotech startups, "ut they apply
to a much wi#er range of companies than that$
9ou see e!erything from mature "usiness ser!ice companies to energy firms to
transportation firms going pu"lic, "ut they get far less attention than hot tech startups
3see Renaissance :apital for up#ate# lists4$
6ost companies go pu"lic to(
(aise capital for e;pansion efforts or to pay "ack #e"t$
Proide an e)it for e;isting in!estors 0 whether the company is .Eowne#, <:
"acke#, or owne# "y a small group of in#i!i#uals or a single person$
Get an ac*uisition currenc' 0 most pri!ate companies- stock is not
highly !alue#, so it is much easier to ac)uire other companies using stock once
they-re pu"lic$ 'n# raising #e"t to #o #eals can "e easier once you-re pu"lic as well$
(e+ard emplo'ees 0 6aking employees work cra=y hours for >7? years is
tough to pull off, "ut the lure of an I.* that will make them all wealthy is a great
incenti!e for them to stick aroun#$
,arket themseles 0 Especially for lesserknown companies in 1"oring2
in#ustries, an I.* is a great way to increase prestige an# attract new in!estors,
partners, an# customers$
'n# sometimes there are technical reasons as well( in the 5@, for e;ample, the 1>??
sharehol#er rule2 use# to re)uire any pri!ate companies with more than >??
sharehol#ers to pu"licly #isclose their financial statementsA
A@o they might as well +ust go pu"lic an# get the other "enefits 0 this was one of the
key reasons why Boogle #eci#e# to go pu"lic in C??D$
,hy is Face"ook going pu"licE -one of the aboe.
It-s cash$rich an# massi!ely profita"le, so it has no nee# for capital$
6any of its in!estors an# early employees ha!e alrea#y e)ited "y selling to
others !ia secon#ary e;changes or in latestage growth e)uity financings 0 options
that #i#n-t e;ist in the past$
It has always ha# a great ac)uisition currency "ecause its pri!ate stock was
worth a lot an# was acti!ely tra#e# on these secon#ary e;changes$
:ome on, #oes it really nee# more marketing an# hypeE
'n# oh yeah, the >??sharehol#er rule is in the mi#st of a re!amp an# Face"ook
got aroun# it anyway "y issuing Restricte# @tock 5nits 3R@5s4 rather than actual
shares or options to employees as the company grew$
' num"er of theories ha!e "een put forth for why it-s really going pu"lic(
@ome people still think the /##$shareholder rule force# their han# e!en
though it-s "eing raise# to C,??? sharehol#ers soon$
6any "elie!e that long$term capital gains ta) rates will increase in the near
future 0 if they go pu"lic an# employees sell stock now, they-ll pay 7>8 rather than a
potentially much higher rate$ 9ou can ask E#uar#o @a!erin a"out that oneA
*thers ha!e theori=e# that they-re using the money for mysterious
newmoneti0ation methods that will e;pan# their re!enue "ase "eyon# a#!ertising$
.ersonally, I #on-t "uy into any of those as in#i!i#ual reasons 0 it was likely a
com"ination of some of the points a"o!e, plus the fact that latestage in!estors still nee#
someone to sell their shares to$
The 1o+nsides of Going Public2 and !h' Facebook ,ade IPOs Irreleant?
@ome companies #on-t want to go pu"lic 3or can-t go pu"lic4 "ecause(
%hey ha!e to gi!e up control an# answer to sharehol#ers with )uarterly earnings
reports$
%hey aren-t <: or .E"acke# an# therefore #on-t nee# an e)it$
%hey-re alrea#y highly profitable an# ha!e no nee# for cash$
3ompliance costs are much higher as a pu"lic company #ue to legislation like
@ar"anes*;ley$
%hey-re too small 0 it-s tough to go pu"lic if you ha!e un#er F>? million in
re!enue$
Gut Face"ook change# the rules here "ecause(
74 6ark Hucker"erg maintaine# far more control than typical foun#ers "y splitting the
stock into !oting an# non!oting shares, "y controlling the Goar#, an# "y selling almost
nothing along the wayI an#
C4 It raise# FC?? million from Jigital @ky %echnologies 3J@%4 in 6ay C??K, an# then an
e!en "igger roun# of F7$> "illion in Lanuary C?77, which effecti!ely ga!e early in!estors
the e;it they nee#e#$
%he rise of secondar' e)changes like @econ# 6arket, where in!estors can "uy an#
sell pri!ate company shares, has ma#e it much easier for early employees to cash out
long "efore the company e!er goes pu"lic$
!ho 1ecides if the 3ompan' Should Go Public?
In most cases, it-s up to the Goar# an# ma+or sharehol#ers$
@o if a pri!ate e)uity firm owns a company an# they nee# to achie!e an e;it in year D or
> to get accepta"le returns, they might push for the company to go pu"lic 3or get
ac)uire#4 aroun# then$
'n# it has tra#itionally worke# the same way with !enture capital firms that often en# up
controlling tech startups$
Gut since Face"ook-s :E* owns CM8 of its stock an# >N8 of its !oting rights, he has
significantly more leeway than the usual foun#erO:E* 0 an# can make #ecisions on
"illion#ollar ac)uisitions in a weeken# without e!en notifying the Goar#$
E!en with that much control, though, he woul# not "e a"le to initiate something like an
I.* without pulling in e!eryone else 0 there-s far too much work to #o an# too many
#ecisions to "e ma#e in the process$
The IPO Process4 Part 5 6 The Pitch
In most cases, "ankers from many firms ha!e "een speaking with the company in
)uestion an# #e!eloping relationships for years 0 so they-re likely to know the
company-s intentions well in a#!ance$
If not, the company itself will reach out to "ankers an# in!ite them in to pitch for the
"usiness$
%his is when you, the "anking analyst or associate, get to stay up all night crafting 7??
page pitch "ooks an# hoping you-!e remem"ere# to #ot all your i-s an# cross all your t-s$
'fterwar#s, the company selects "anks for book runner roles an# picks other "anks to
"e co$managers , "ase# on its relationships with them, their pitches, an# what the "anks
ha!e #one for them in the past$
*ther factors might inclu#e "anks- I.* track recor#s an# their reputation an#
relationships with institutional in!estors$
In the case of Face"ook, at first people thought that Bol#man @achs woul# lan# the lea#
role "ecause it helpe# arrange F7$> "illion of financing in C?77A
Gut then B@ "otche# the #eal "y getting on the @E:-s "a# si#e when it inclu#e# its 5@
clients at first, an# then re!oke# the offer later 0 resulting in 6organ @tanley winning the
lea# spot$
6ost I.*s ha!e at least 7C "anks as book runners an# then a few more as co$
managersI Face"ook is unusual "ecause it has 5" banks #ue to the si=e an# prestige
of the offering$
Part " 6 The 7ick$Off ,eeting
E!eryone in!ol!e# in the I.* 0 company management, au#itors, accountants, the
un#erwriting "anks, an# lawyers from all si#es 0 atten#s this meeting$
9ou spen# the #ay #iscussing the offering, the re)uire# registration forms, figure out
who-s #oing what, an# #etermining the timing for the filing$
'n# then you ha!e similar allhan#s meetings like this throughout the rest of the
process$
It-s actually )uite boring for you as a +unior "anker atten#ing these "ecause you #on-t
participate too much 0 you-re mostly +ust there to take notes$
Ongoing 1ue 1iligence
'fter that initial kickoff meeting, all the "ankers, accountants, an# lawyers in!ol!e# nee#
to #o a lot of due diligence on the company to make sure that their registration
statements are accurate$
:ommon tasks here inclu#e(
3ustomer 3alls 0 %his is pro"a"ly the most interesting task, "ecause sometimes
you hear cra=y O interesting things from customers that you-# ne!er learn a"out
otherwise$
Industr' 8 ,arket 1ue 1iligence 0 9ou-ll ha!e to research the market, speak
with e;perts, an# figure out where it might "e hea#e# in the future$
9egal and IP 1ue 1iligence 0 Lawyers han#le most of this 0 it consists of
re!iewing contracts, registrations, an# other #ocuments$ 'ren-t you gla# you #on-t
want to "e a lawyerE
Financial and Ta) 1ue 1iligence 0 'ccountants #o most of this an# com"
through historical financial statements, ta; returns, an# so on, an# look for
irregularities$
Face"ook is an interesting e;ample "ecause 1customer calls2 apply in a #ifferent way
from what you might e;pect 0 their 1customers2 are not in#i!i#ual users so much as
the companies that adertise on the site$
@o "ankers here likely calle# the larger a#!ertisers an# also spent time talking to key
partners such as Hynga$
%hey might ask )uestions like(
're you planning to increase O #ecrease a#!ertising spen#ingE
,hat-s your relationship with the company "een like so farE
,hat #o you see as key risks going forwar#E
,hat other social networks #o you a#!ertise on, an# what #o you think of themE
Part % 6 The S$5 Filing
%he en# result of this entire process, which might take months, is the S$5 (egistration
Statement 3names !ary in other countries4$
%his is where all the +uicy information comes out 0 historical financial statements, key
#ata, who-s selling shares an# how many they-re selling, the company o!er!iew, risk
factors, an# more$
,hen Face"ook file# its own @7, there were so many !isitors that the go!ernment-s site
actually crashe#$
%he company waits 3? calen#ar #ays for comments from the @E: 3or e)ui!alent
organi=ation in other countries4, an# the legal team respon#s to e!erything once they
hear "ack$
Note that the company neer lists pro+ecte# financial statements in its @7 0 they might
ha!e pro+ections internally, of course, "ut they-re not part of the registration statement$
Part : 6 Pre$Selling the Offering
*nce the @7 is file# an# the team is working through re!isions, the company can hol#
a pre$IPO anal'st meeting where they e#ucate "ankers an# analysts on the company
an# 1teach2 them how to sell it to in!estors$
It can also start speaking to in!estors an# issue a 1re# herring2 3preliminary prospectus4,
which "ankers #raft 3similar to the @7, "ut shorter an# more focuse# on sales4$
:ompanies are encourage# to wait until the @E: respon#s to the @7 with comments
"efore printing the re# herring$
%his #ocument may omit the offering price, un#erwriting #iscounts O commissions,
#iscounts O commissions to #ealers, the amount of the procee#s, an# so on 0 it-s +ust
a"out selling the company-s stor' to in!estors$
*nce this #ocument is in place, pre$marketing starts an# usually lasts aroun# C weeks$
Research analysts meet with institutional in!estors 7 on 7 an# tell them a"out the
company, an# sales teams at "anks maintain close contact with in!estors an# figure out
what they think 0 #o they like the sectorE %he company itselfE ,hat price will they payE
Gase# on fee#"ack from these meetings an# their own internal !aluations, "anks set
a price range for the offering$
,ith some companies this can "e enlighteningI with Face"ook it was
)uiteboring "ecause the company ha# alrea#y "een acti!ely tra#e# on secon#ary
e;changes long "efore the I.*, so e!eryone knew what the rough price range woul# "e$
Picking Inestors to ,arket To
' "ank #oesn-t +ust pick the in!estors ran#omly 0 they select firms "ase# on criteria like(
;rokerage 3ommissions 0 If you-re making tons of money from certain
institutional in!estors, they-ll "e high on the priority list$
Interest and Track (ecord 0 If the firm ne!er #oes tech in!estments, for
e;ample, the "ank may +ust skip showing them tech I.*s$
Potential ;rokerage Fees 0 If a "ank wants to win more "usiness from
institutions in the future it might show them a 1hot2 I.* as a fa!or$
%he e)uity syn#icate, sales, an# roa# show management teams han#le this process$
<mending the S$5 Filing
'fter all this premarketing work is #one, "anks amen# the @7 filing with a re!ise# price
range "ase# on fee#"ack from in!estors$
@ometimes there are #ramatic shifts in the price range, "ut it-s more common to see
small mo!es in one #irection or the other$
*nce again, since Face"ook stock ha# alrea#y "een acti!ely tra#e# long "efore the
offering, this part of the process likely wasn-t as interesting for them$
Part / 6 The (oadsho+
'n# now for the fun, e;hausting part of the process( management gets to tra!el all o!er
to meet with in!estors an# market the company for 7C weeks$
@ometimes management teams make themsel!es !ery open an# accessi"le an# go out
of their way to win o!er in!estors an# answer )uestions$
6ark Hucker"erg took the e;act opposite approach, mostly "ecause he coul# affor# to 0
he coul# show up to ? meetings an# in!estors woul# still "e falling all o!er themsel!es to
get shares$
For normal companies, though, this process is e;tremely important "ecauseorders are
also taken at this time 0 in!estors can state how many shares they want an# what price
they-re willing to pay$
6anagement gets #aily up#ates on what the or#ers are looking like, an# the "anks
in!ol!e# in the process all try to oneup each other "y claiming that they won the "iggest
or#ers from in!estors$
Juring this time, "ankers keep getting more an# more fee#"ack from in!estors an# may
further re!ise the price range 0 that-s why Face"ook change# its own range from FCM 0
F3D to F3D 0 F3M$
It-s a tricky "alancing act "ecause no one +ants to leae mone' on the table 0
"ankers want a higher share price so they can earn higher fees, sharehol#ers who are
selling o"!iously want a higher price, an# the company wants as high a price as possi"le
to ma;imi=e their cash procee#s$
Gut if the price range is set too high, "ankers may ha!e to re!ise it #ownwar#, which
sen#s a negati!e signal to the market$
Juring this time, the company might also increase or #ecrease the num"er of shares it-s
offering 0 "ut if it #oes that too much 3in either #irection4 it may "e taken as a negati!e
sign "ecause in!estors might think the company #oesn-t know what it-s #oing with the
procee#s$
%here-s "een a lot of #e"ate o!er "oth the si0e of Face"ook-s offering 3as a percentage
of the company, small, "ut !ery high in a"solute #ollar terms4 an# the price$
Relati!ely few companies worl#wi#e are actually worth more than F7?? "illion 5@J,
san# many o"ser!ers think that Face"ook may "e o!er!alue# at its current price range
an# that growth coul# "e flattening out$
.art of what makes Face"ook-s !aluation so uncertain is that its future business might
"e far #ifferent from what it looks like to#ay 0 a#!ertising re!enue might not e!en "e
significant in >7? years an# payments, mo"ile, or something else entirely might take
o!er$
Part = 6 The Pricing ,eeting
*nce the roa#show is o!er an# the or#er "ook is close#, the management team will
meet with "ankers an# #eci#e on the final price of the #eal "ase# on the or#ers
recei!e#$
If a #eal is o!ersu"scri"e#, the company will price the company at the high en# of the
range an# will #o the opposite for un#ersu"scri"e# #eals$
@ometimes management will #eli"erately price the company at a lower price 3lea!ing
some money on the ta"le4 so the stock can tra#e up on the 7st #ay of tra#ing 0 always a
positi!e in#icator to the market$
5sually companies that tank after the 7st #ay of tra#ing ha!e a har# time reco!ering an#
getting "ack to their initial price$
Fee#"ack was clearly !ery positi!e for Face"ook, since it set its price at>%? the high
en# of the range$
Part @ 6 <llocation
*nce the #eal is price#, the syn#icate team of the "anks will allocate shares to
in!estors$
,hile "anks try to allocate to in!estors who will "e longterm hol#ers of the stock, "anks
may "e "iase# at times to rewar# in!estors that generate the highest "rokerage
commissions 3e$g$ he#ge fun#s who are tra#e !ery acti!ely4$
%he syn#icate team usually works o!ernight to allocate the #eal$
Part ? 6 Trading
*nce the #eal is allocate# an# e!eryone has their shares, the stock starts tra#ing an#
1the general pu"lic2 can "uy an# sell shares$
So4 Ao+ ,uch 1o ;anks Barn From <ll This?
I.* fees typically range from % 6 @& #epen#ing on the si=e of the company, how well
known it is, an# how much e;tra work an# risk "anks ha!e to take on to sell it$
9es, you rea# that correctly( for a F7?? million offering, "anks coul# potentially make >@
million 3now you really un#erstan# why they make so much money4$
Gut for e;tremely large offerings the fee #rops, an# it #rops e!en further when it-s 1hot2
an# e!eryone wants to "e in!ol!e#$
@o Face"ook is only paying "ankers a 5C5& fee on its offering, which will still e)ual >5@=
million when all is sai# an# #one$
For "ankers, "eing in!ol!e# in the largest tech I.* e!er is worth far more than e!en a
su"stantial increase in fees "ecause they market themsel!es "ase# on their track
recor#s$
<re the Fees Dustified?
It #epen#s on how much the "ankers actually help$
For something like Face"ook, the fees are less Eustified than normal0 sure, the "ankers
help manage the process an# #o a lot of the grunt work, "ut who really nee#s con!incing
to "uy Face"ook stockE
%he fees are more +ustifia"le for smaller an# lesserknown companies that re)uire real
selling 0 an# when "ankers actually help with a##ressing key in!estor concerns an#
winning more interest in the company$
Gack in the #ay "anks use# to take on su"stantial risk themsel!es "y "uying the shares
first an# then reselling them 31firm commitment24, which they use# to +ustify higher fees$
Gut this is less common now, so there-s certainly #ownwar# pressure on fees$
!ill Fou ;e ;u'ing F; Shares?
I-m staying away "ecause great companies donGt necessaril' make for great
inestments$
'lso, I.*s ha!e historically under$performed the market "y C38 0 not a great sign if
you-re going "y statistics$
*f course, "y the time you rea# this the share price will pro"a"ly ha!e 1poppe#2 to a
much higher num"er an# I-ll look silly for not ha!ing in!este#$
Gut we-ll see where things stan# after a month, N months, or a year$
'n# if you #eci#e to in!est, let us know how it goes an# what price you get in 3an# outE4
at$
For Further (eading:
.w: 0 I.* Roa#map an# Bui#e to Boing .u"lic
.an#oJaily 0 Bui#e to the Face"ook I.*
@peculati!e Face"ook <aluation
Nicole Lee has worked in institutional sales, private banking, and investment banking in
Hong Kong. When shes not working, she enjoys kiteboarding at eotic beaches,
jumping o!! planes and bridges, and shark"diving.
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