The IPO Process

Pre-IPO Preparation

The Initial Public Offering is one of the most significant events in a company's life, transforming it from a privately held enterprise to a publicly traded company. For the Series 79 exam, you must understand every phase of the IPO process, from the initial decision to go public through the aftermarket period. This chapter provides a comprehensive, investment-banking-focused analysis of the IPO timeline, the roles of key participants, and the regulatory framework governing public offerings.

The decision to pursue an IPO is driven by several strategic considerations. Companies seek public offerings to raise capital for growth, provide liquidity for existing shareholders (founders, venture capital, private equity), establish a public currency for future acquisitions, enhance the company's public profile and credibility, and create equity-based compensation programs to attract and retain talent. The investment bank advising on the IPO must assess whether the company is "IPO-ready" across multiple dimensions.

Selecting the Underwriter

The IPO process typically begins with the company selecting one or more investment banks to serve as underwriters. This selection process, known as a "bake-off" or "beauty contest," involves presentations from competing investment banks. Each bank presents its assessment of the company's valuation, recommended offering structure, distribution capabilities, research coverage plans, and proposed fees. Key factors in the selection include:

• Industry expertise: Track record of underwriting IPOs in the company's industry
• Distribution capability: Access to institutional and retail investors
• Research coverage: Quality and reputation of the bank's equity research analysts
• Aftermarket support: Commitment to providing market-making and stabilization
• Valuation and pricing: Preliminary assessment of valuation and offering size
• Reputation: The bank's standing in the market and with institutional investors

The selected bank becomes the lead underwriter (or "book-running manager"). For larger offerings, multiple book-runners may share the lead role. Additional banks may be included as co-managers to provide broader distribution.

Organizational Meeting and Timeline

Once the underwriter is selected, an organizational meeting (also called the "org meeting" or "all-hands meeting") brings together all parties: the issuer's management, the issuer's legal counsel, the underwriter's team, the underwriter's legal counsel, and the independent auditors. This meeting establishes the working timeline, assigns responsibilities, identifies key issues, and sets the target filing and pricing dates. A typical IPO process takes 4 to 6 months from the organizational meeting to the offering date.

Registration and Filing

Under the Securities Act of 1933, securities offered to the public must be registered with the SEC unless an exemption applies. The registration process is the legal framework that ensures investors receive adequate disclosure about the issuer and the securities being offered.

The Registration Statement

The registration statement is the foundational document filed with the SEC. For IPOs, the most common form is Form S-1. The registration statement consists of two parts:

• Part I (The Prospectus): The disclosure document that must be delivered to every purchaser of the securities. It contains a detailed description of the company's business, risk factors, financial statements (audited for the past two or three years), management discussion and analysis (MD&A), use of proceeds, dilution analysis, management and executive compensation, related-party transactions, and a description of the securities being offered.
• Part II: Additional information not required in the prospectus, including exhibits (material contracts, legal opinions, consent of auditors), financial statement schedules, and undertakings.

The Cooling-Off Period

Once the registration statement is filed, the SEC conducts a review, which typically takes a minimum of 20 days (the "cooling-off period"). During this period, the SEC staff may issue comment letters requesting additional disclosure, clarification, or modifications. The issuer responds to these comments, and the process continues iteratively until all comments are resolved.

During the cooling-off period, certain activities are permitted and others are prohibited:

• Permitted: Distribution of the preliminary prospectus (the "red herring"), oral offers to sell (including the road show), and indications of interest from investors (not binding commitments)
• Prohibited: Sales of securities, acceptance of money from investors, and written offers to sell other than the statutory prospectus or free writing prospectus (if used)

Road Show and Book Building

The road show is a marketing event during which the company's management team and the lead underwriter present the investment opportunity to institutional investors across multiple cities, typically over a 1-2 week period. The road show serves several purposes: it educates investors about the company, generates demand for the offering, and provides the underwriter with critical feedback for pricing.

The Book-Building Process

During the road show, institutional investors express their interest through indications of interest (IOIs), specifying the number of shares they would like to purchase and, in some cases, the price they are willing to pay. The lead underwriter compiles these IOIs into an order book, which provides a demand curve showing how many shares investors are willing to buy at various price levels.

The quality of the book is as important as the quantity. Investment bankers look for:

• High-quality institutional investors: Long-only funds, sovereign wealth funds, and established investors who are likely to hold shares rather than flip them immediately
• Diversified demand: Orders from a broad range of investors across geographies and investment styles
• Price sensitivity: Understanding which investors are price-sensitive and which are committed regardless of the exact offering price
• Oversubscription: The book is typically oversubscribed (more demand than supply) to ensure a successful offering and positive aftermarket performance

Pricing the IPO

On the evening before the first day of trading (the "pricing night"), the lead underwriter, the issuer's management, and their advisors agree on the final public offering price (POP). This price is determined through an analysis of the order book demand, the company's valuation (using the methodologies discussed in Chapter 3), comparable company valuations, market conditions, and investor feedback from the road show.

The goal is to price the IPO at a level that is attractive to investors (providing some upside from the offering price) while maximizing proceeds for the issuer. IPOs are typically priced to allow a first-day "pop" of 10-15%, which rewards early investors and creates positive momentum. However, too large a pop suggests the offering was underpriced, leaving money on the table for the issuer.

Allocation and Aftermarket Activities

Share Allocation

After pricing, the lead underwriter allocates shares to investors. Allocation is a critical and sensitive process. In an oversubscribed offering, not all investors will receive their requested allocation. The lead underwriter typically allocates based on several factors: the quality and investment horizon of the investor, the size and price sensitivity of their order, the investor's relationship with the underwriter, and the goal of building a stable, long-term shareholder base.

FINRA rules (particularly Rule 5131) govern the IPO allocation process to prevent abusive practices. Key restrictions include prohibitions on spinning (allocating IPO shares to executives of potential investment banking clients as an inducement for business), quid pro quo arrangements (conditioning allocations on the receipt of excessive compensation), and flipping restrictions (though penalizing flippers is generally permitted).

Stabilization

Stabilization is a post-offering activity in which the lead underwriter places bids to support the market price of the newly issued securities. It is the only form of market manipulation permitted under Regulation M of the Securities Exchange Act of 1934. Key rules include:

• The stabilization bid cannot exceed the public offering price
• Stabilization activities must be disclosed in the prospectus
• Only the lead underwriter (or a designated syndicate member) may conduct stabilization
• Stabilization is intended as a temporary measure to prevent short-term price declines, not to artificially maintain the price indefinitely

The Overallotment (Green Shoe) Option

The overallotment option (commonly called the "Green Shoe" after the first company to use it, Green Shoe Manufacturing) allows the underwriter to sell up to 15% more shares than the original offering size. This option serves two purposes:

1. Meeting excess demand: If demand is strong, the underwriter can sell additional shares to satisfy investor interest
2. Stabilization tool: The underwriter initially oversells the offering (creating a short position) and then either exercises the Green Shoe to cover (if the stock trades above the offering price) or buys shares in the open market to cover (if the stock trades below the offering price, which supports the price)

Lock-Up Period

The lock-up period is a contractual agreement (not a regulatory requirement) in which insiders, including company executives, directors, and pre-IPO shareholders, agree not to sell their shares for a specified period after the IPO, typically 180 days. The lock-up protects the offering by preventing a flood of insider selling that could depress the stock price. The lead underwriter may grant early release from the lock-up at its discretion.

Prospectus Delivery Requirements

Every purchaser in the IPO must receive a final prospectus. The prospectus delivery obligation extends beyond the offering itself. Under the Securities Act, dealers must deliver a prospectus for IPO securities for 25 days after the effective date if the company is listed on a national exchange, or 90 days if it is not listed.

Special IPO Considerations

Direct Listings

A direct listing is an alternative to a traditional IPO in which a company lists its shares on a stock exchange without issuing new shares or using underwriters. Existing shareholders sell their shares directly to public market investors. Direct listings have gained popularity because they avoid underwriting fees, eliminate the lock-up period, and allow price discovery through the open market rather than the book-building process. However, direct listings do not raise new capital for the company (unless structured as a "direct listing with a capital raise," as approved by the SEC and NYSE in recent years).

Special Purpose Acquisition Companies (SPACs)

A SPAC is a shell company that raises capital through an IPO with the purpose of acquiring an existing private company, effectively taking it public through a reverse merger. The SPAC typically has 18-24 months to identify and complete an acquisition (the "de-SPAC" transaction). If no acquisition is completed within the timeframe, the SPAC liquidates and returns funds to investors. SPACs offer an alternative path to public markets that may be faster and provide more pricing certainty than a traditional IPO.

Emerging Growth Companies (EGCs)

The JOBS Act of 2012 created the category of "Emerging Growth Company" (EGC), providing accommodations for smaller companies going public. An EGC is a company with total annual gross revenue of less than $1.235 billion in its most recent fiscal year. EGC benefits include reduced financial statement requirements (two years of audited financials vs. three), exemption from certain Sarbanes-Oxley requirements, the ability to "test the waters" by communicating with institutional investors before filing, and confidential filing of the registration statement.