A Primer on Initial Public Offerings (IPOs)

March 29, 2022

An initial public offering (IPO) can be a major milestone for a private company. It signifies that a company is ready for the public markets, having reached a certain level of growth and predictive performance.

While multiple paths to the public markets exist today – including SPACs and Direct Listings - IPOs are still the vehicle of choice for many companies. Roughly 480 private companies went public via IPO in 2020 and raised a combined $168 billion.1

IPOs are notoriously complex; however, this article will focus on providing a high-level overview of 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 issues new securities to public market investors via a stock exchange like the Nasdaq or New York Stock Exchange. When a company completes an IPO, its shares are available for trading by retail investors and that means that is subject to enhanced financial, regulatory and disclosure requirements mandated by the SEC.

Why do Companies Conduct IPOs?

There are three primary objectives of an IPO:

  1. An IPO is an opportunity to raise capital from a broaden 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.
  1. IPOs are also a major liquidity event for a private company, allowing existing investors and shareholders to divest their equity holdings for cash. IPOs were once the only major liquidity event in the lifecycle of a private company; however, today more private companies are offering recurring shareholder liquidity via liquidity events. Still, an IPO is generally understood to be a more substantiative liquidity event, particularly for VCs and other early investors.
  1. IPOs can also 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 some sort of 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 file for an IPO. In the past, companies were forced to go public by the SEC once they had 500 shareholders; however, that rule changed to 2,000 shareholders in 2012. That, combined with an abundance of capital flowing into the private markets and more flexibility to offer recurring shareholder liquidity via liquidity events has essentially allowed companies to stay private indefinitely if they wish to. In fact, the median age of a company at IPO has nearly doubled over the last two decades. 2

Today, conducting an IPO is more of a strategic decision for an established private company looking to start the next phase of their growth cycle. While an IPO’s timeline can sometimes be accelerated by liquidity pressure from shareholders, capital needs, or built-up investor demand, companies are often advised to only pursue an IPO when they are ready. Again, there’s no defined set of criteria for what constitutes IPO readiness, but generally a company should be reasonably confident that it has or can achieve:

  • A clearly defined and established business model with several quarters of measurable growth or success.
  • The resources, capital and infrastructure required to manage the IPO process for a prolonged period of time (IPOs can sometimes take months or even years).
  • An understanding of the long-term growth and equity impact an IPO will have on the business and its employees.

What’s Involved in the IPO Process?

IPOs are complex and involve a lot of moving parts, but at a high-level IPOs follow this process:

  1. 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.
  2. Next, the company and underwriters will work out the terms of the agreement and submit an S-1 Registration Agreement and other necessary paperwork to the SEC.
  3. Underwriters will typically then 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.
  4. Once the company’s S-1 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 tons of paperwork and provide audited financials and other disclosures to their underwriting team. At the same time, 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 After the 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 S-1 filing. On the day of actual IPO, the company’s shares are listed on an exchange and the share price will fluctuate based on market demand. It is not uncommon for share prices to fluctuate wildly from the initial offer price days or even weeks after the IPO. Many companies hedge against this by instituting 90-180 “lock-up” periods during which existing shareholders are not allowed to sell their stock.

After the initial IPO is complete and the buzz has died down, the company is now public and expected to file earning reports initially after the first 45 days and then quarterly and annually.

Is an IPO Right for Your Business?

For later-stage private companies with established business models and ambitious growth, IPOs may be next logical step in their lifecycle. However, IPOs are a big business decision and financial undertaking. Private company leaders should carefully weigh the pros and cons of an IPO and seek outside guidance, when necessary, in determining the right path.

Considering an IPO in the near-future? Morgan Stanley at Work can provide guidance and support throughout the IPO process and beyond. Contact us to learn more.

 


1 Statista, “Number of IPOs in the United States from 1999 to 2020”

2 McKinsey, “Grow Fast or Die Slow: Why Unicorns are Staying Private Longer”

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