A Primer on Initial Public Offerings (IPOs)
Initial public offerings (IPOs) were in the spotlight in 2022. While 2021 was a record year for new IPO listings, as of late September, 2022 saw a 44% decrease in IPO volume.1 Fears of an economic recession coupled with rising inflation and a global crisis in Ukraine have prompted more private companies to delay or rethink their plans to go public. Despite the market volatility in 2022, the IPO window will open again at some point but we’re anticipating many private companies are going to stay private longer through this period.
While private company leaders wait for market volatility to play out, there are several actions they can take to get “IPO ready” for when markets turn around. One critical action is educating themselves on the basics of IPOs. IPOs are notoriously complex. This article will focus on providing a high-level overview of certain key questions related to what IPOs are, when to consider one and what a company can expect during the IPO process.
Initial Public Offering Definition: What is an IPO?
An IPO occurs when a privately-held company offers its securities for the first time to public market investors via a stock exchange like the Nasdaq or New York Stock Exchange. In advance of an IPO, the company will need to file registration documents with the Securities and Exchange Commission (“SEC”). When a company completes its IPO, its shares will be available for trading by retail investors and the company will be subject to enhanced financial, regulatory and disclosure and on-going governance requirements mandated by the SEC and the stock exchange where it is listed.
Why Might a Company Conduct an IPO?
Three primary objectives of an IPO are:
- An IPO is an opportunity to raise capital from a broader pool of institutional and retail investors. Unlike a private fundraise, typically only open to venture capital firms, institutions and select accredited investors, an IPO is typically open to all retail investors. This allows a company to raise potentially more money and from a much larger and more diversified pool of potential shareholders.
- In many cases, IPOs are a major liquidity event, allowing existing investors and shareholders to sell their equity holdings. IPOs were once the primary liquidity event in the lifecycle of a private company other than an acquisition; however, today more private companies are offering recurring shareholder liquidity via liquidity events. Still, an IPO is frequently a more substantial liquidity event, particularly for VCs and other early investors.
An additional benefit is that the IPO process can broaden exposure for a company and generate publicity that can be used to help the business grow. This begins during the IPO on-ramp process, when companies will begin courting investors through “roadshows” all the way to their actual IPO, which typically attracts significant press coverage.
An IPO provides companies with a unique opportunity to connect with a broader audience and invite them to participate in their future success.
When Should a Company Consider an IPO?
There is no hard-set rule for when a company should consider an IPO. In the past, public reporting of financial statements and certain other information was required once a company had more than 500 shareholders. That limit was changed to 2,000 shareholders in 2012.2 That change, combined with an abundance of capital flowing into the private markets and more flexibility to offer liquidity via recurring shareholder liquidity events has allowed companies to stay private longer.
Deciding to conduct an IPO is a strategic decision for a company, and the timing of an IPO can sometimes be accelerated by liquidity pressure from shareholders, capital needs or built-up investor demand. For companies looking to thoughtfully prepare for an IPO, building a strong technological infrastructure and having ample resources at hand may be keys to success. Furthermore, having these systems in place isn’t just helpful in preparing for an IPO or on the day of the event, but also in streamlining the daily operations required to support public company trading afterwards.
What are some of the steps in the IPO process?
IPOs are complex and involve a lot of moving pieces, but at a high-level IPOs include some of the following steps:
- A company will choose an investment bank to be the underwriters of the IPO and be responsible for pricing the offering, buying the shares from the company, and finding investors to purchase an initial block of shares.
- The company and its underwriters will work out a deal structure for the offering, including the terms of the lock-up release. The company and its counsel will typically file a registration statement on Form S-1 with the SEC.
- Underwriters will typically organize an IPO Roadshow, used to pitch the company to different investors and understand demand and what investors might be willing to pay for the company’s shares.
- Once the company’s registration statement is approved and roadshows are complete, the company and its underwriter then determine the final initial offer price for the IPO along with the intended IPO date.
All of this happens over several months and, in some cases, potentially even years. Within each of these steps companies will have to complete extensive paperwork and provide audited financials and other business-related disclosures to their underwriting team. Companies will also use this time to share their IPO plans with employees, helping them to understand how it will impact the business and them.
What Happens Leading up to and on the Day of an IPO?
Leading up to the IPO, there’s a mandatory 25-day quiet period in which the company going public is prohibited from disclosing any information not contained in their registration statement. On the day of the actual IPO, the company’s shares are listed on an exchange and the share price will change based on market demand. It is not uncommon for share prices to fluctuate significantly from the initial offer price during the days and weeks after the IPO. Many companies hedge against this volatility by instituting 90-180 day “lock-up” periods during which existing shareholders are not allowed to sell their stock.
After the IPO is complete, the company is referred to as “public” and required to file financial statements and earnings reports on a periodic basis, such as after the first 45 days, quarterly and annually.
Is an IPO Right for Your Business?
For later-stage private companies with established business models, IPOs may be a next logical step to consider. However, IPOs are a major decision and significant financial undertaking. Private company leaders should carefully weigh the pros and cons of an IPO and seek outside guidance in determining the right path.
Considering an IPO in the near future? Morgan Stanley can provide stock plan administration guidance and support throughout the IPO process. Contact us to learn more.
1 Global IPO market continues to plummet as Q3 draws to a close (prnewswire.com)