The Process

Once the team is assembled and the underwriter is chosen, the actual IPO process begins. The entire process is usually composed of the following stages:

  • Preparing the company (see the section on preparing the company for an IPO)

  • Assembling the team (see the section on forming the IPO team)

  • Signing a letter of intent with the underwriters

  • Beginning of the quiet period

  • Holding the organizational meeting

  • Preparing a preliminary registration statement (the first draft prospectus)

  • Conducting the due diligence process concurrently with the preparation of the preliminary registration statement

  • Filing the preliminary registration document with the SEC for examination

  • Preparing an amended registration statement

  • Distributing the preliminary prospectus ("red herring")

  • Marketing ("road show")

  • Holding the due diligence meeting

  • Pricing, signing the underwriting agreement, and having the registration statement declared effective

  • Selling the shares to the public and closing

  • Trading, stabilization, and exercise of the underwriters' option ("green shoe" option)

Signing the Letter of Intent

After the underwriter is chosen, a letter of intent specifying the proposed terms of the IPO and declaring the underwriters' readiness to sign an underwriting agreement before the conclusion of the registration process is usually (but not always) signed. The letter (which is not binding) also specifies the payment to the underwriters, the type of underwriting agreement, and the underwriters' estimate of the range of prices at which they expect to be able to sell the shares (which estimate is also not binding). The projected price range may be updated several times during the road show, until the final pricing.

Quiet Period

From the moment a preliminary agreement is reached with the underwriters, a quiet period begins during which the company is subject to the SEC's rules on the publication of information. The quiet period lasts until 25 days after the effective date of the registration statement, or until all the shares are sold to the public (as is usually the case). The possibility of rousing interest in the company and the IPO is limited in order to prevent gun-jumping, namely, attracting interest to the securities other than through an effective prospectus. U.S. securities rules explicitly prohibit the publication of information on the offering in the U.S. media (other than very limited information as defined in the regulations); limit contacts with U.S. analysts and brokers during the quiet period; and restrict the distribution of reports on the company before the IPO. It should be noted that broad changes have been proposed in the method of registration in the United States (a proposal known as the "Aircraft Carrier Release" see the discussion in the section on changes in the registration process), within which the rules governing the publication of information before an IPO would be changed. In any case, even now the rules permit publications within the ordinary course of business.

Many issues have been brought before the SEC in recent years, since many companies interview and advertise their products vigorously during the quiet period, and there are many doubts as to whether these acts constitute a prohibited promotion of the IPO. These issues are at the center of a public debate following the collapse of the prices of technology firms, and in particular Internet firms.

Organizational Meeting

After the team is assembled and the underwriter is chosen, the registration process itself may commence. The process usually begins with an organizational meeting attended by the company's managers, the underwriters, the legal counsels, and the CPAs. At this meeting, the method of the offering, the type of registration statement to be used, the timetables, and the responsibility of each participant for the various tasks are discussed. A preliminary decision of the type and scale of the capital to be raised is also made.

Preparing the Preliminary Registration Statement

The preliminary document is the first copy of the registration statement which will be filed with the SEC and is typically also used as the initial share sale document (see the section on the registration statement). The document is written jointly by the underwriter, the company, the attorneys, and the CPAs. The preparation of the document also includes drafting sessions which are held over the course of several weeks (see the section on disclosure particulars for a specification of the disclosures required in the document).

Due Diligence

The due diligence process includes examining the company's financial and business condition and perusing the disclosure documents of the offering in order to prevent the inclusion of a misleading detail or the omission of a material detail. The examination is made according to customary international standards which are based on the protection afforded by U.S. law to whomever conducts a "reasonable investigation" of the company. The need for a due diligence process derives from the U.S. securities rules, which exempt the underwriters from liability on account of a false registration statement, if they had, after judicious investigation, reasonable ground to believe that the statements therein were true and that there was no omission to state a material fact required to be stated therein, or necessary to make the statements therein not misleading.

The due diligence process is performed by the underwriters (with respect to the business portion) and the underwriters' legal counsel, together with the company's independent auditors. The process has to be adjusted to the company's industry and fields of activity and cannot be merely a general investigation. The thorough investigation includes perusing documents (including organizational documents, material contracts, etc.), visiting the company's facilities, questioning the company's managers and customers, obtaining opinions from experts and attorneys and comfort letters from the company's CPAs, and certifying the financial statements and their conformity with the registration statement.

Filing the Preliminary Registration Statement with the SEC

Every registration statement of an IPO is examined by an SEC team, which includes, among others, attorneys and CPAs. The team verifies that the document meets the requirements of the securities rules and neither contains an inaccurate fact nor omits material information. The SEC's CPAs check the statements and the financial information and their compliance with the SEC's rules, U.S. GAAP, the rules of the Financial Accounting Standards Board (FASB) and the rules of the American Institute of Certified Public Accountants. The procedure includes an unofficial process of comments and discussions between the team and the company's consultants, at the end of which an official letter addressing all the issues which need to be taken care of (letter of comments) is sent out. Foreign companies enjoy a special procedure in which they can submit the document with the SEC confidentially (confidential submission) and receive preliminary comments. Only when the document is ready and amended in accordance with the comments is it filed officially and openly.

The Amended Registration Statement

Once all of the SEC's comments are amended and updates are made following developments in the company, if any occurred, an amended statement, which also serves as the prospectus for the offering, is filed.

The Preliminary Prospectus (Red Herring)

The amended registration document is sent to brokers and potential buyers. This document is used to market the shares, and opens with a comment in red print to the effect that the information in it is not complete and may be changed, that the securities may not be sold until the registration statement filed with the SEC is effective, and that it is not an offer to sell nor seeks an offer to buy the securities in any jurisdiction where the offer or sale is not permitted. The preliminary prospectus excludes any information which depends on the IPO price. Historically, the name red herring derived from the red tape used to bind the document (obviously, nowadays, the document is often delivered in electronic form).

Road Show

The IPO is marketed by meetings organized by the underwriters with potential investors, in which the company's managers present the company (road show). The marketing process is very dynamic and requires both professional and emotional preparation. Road shows are usually 2-3 week trips, during which the managers travel through 20-30 different cities in the United States (and if the shares are also distributed in Europe, the road show will include several days in Europe). Some of the meetings are held in large groups and some are one-on-one. In these meetings, the company's management gives a presentation about the company and answers investors' questions, after which the underwriters amass orders (a process known as "book building"). Although these orders are not binding purchase offers, they serve as an important indication of the number of shares which institutional investors would be interested in buying and of the price they could bring. As mentioned above, these orders are not binding because no binding orders may be accepted until the registration statement is declared effective by the SEC.

Due Diligence Meeting

The due diligence process culminates in a meeting held before the registration statement is declared effective (which is when liability attaches to the document). The due diligence meeting is attended by the underwriters, the company's managers, the legal counsel, and the CPAs. During this meeting, the underwriters ask the managers questions about the information in the prospectus and about existing or projected developments in the company and its market, to ensure, before they sign the underwriting agreement and, in fact, buy the company's shares, that no adverse change had occurred.

Pricing, Signing the Underwriting Agreement, and Registration Statement Effectiveness

The final price and precise number of the shares to be sold are determined before the registration statement is declared effective. The price is based on financial multiples in relation to similar companies in the field, as well as on the indications received by the underwriters during the road show. If many orders were placed, the price will be in the top range of the prices determined in the red herring (or even above it), but if few orders were placed, the price will be in the bottom range (or even below it). The final quantity of shares is also determined in the pricing process; any change exceeding 20% of the quantity or the price range set out in the preliminary prospectus requires an amendment of the document (and may delay the process).

Once the price is determined, the underwriting agreement is signed (in other words, the underwriters become obliged to buy the shares at closing, subject to the terms of the underwriting agreement; see further details in the section regarding the underwriting agreement). Immediately thereafter, the information on the quantity and price of the shares is delivered to the SEC, together with a request to have the document declared effective (known as a "request for acceleration of effectiveness"). Once the document is effective (the request is approved within a matter of minutes), shares may be sold pursuant to it, and the company and all of the entities involved in the IPO become liable under the prospectus.

The pricing and distribution method enables the underwriters to determine, together with the company, the correct allocation among investors which will enable a stable trading in the share and a dispersion in accordance with criteria which will best serve the needs of the company's shareholders. Underwriters try to sell most of the shares in the IPO to "strong hands," i.e., institutional investors with a view of long-term holding who believe in the company and its management, and to minimize the number of participants in the IPO who intend to sell the shares immediately after the IPO in order to make a quick profit ("flippers"). Recently, many complaints have been heard in the United States with respect to the identity of the flippers. Surprisingly, many institutional investors who are supposed to belong to the main investors who will hold the share for a long time are actually the main flippers, and it is actually many of the small private investors who are the long-term investors in whom the companies are usually interested.

A customary indication of the success of the IPO is how high the price of the share rises on the first day of trading. However, this indication has no real economic significance besides expressing an additional indirect cost to the company. A more substantive standard from the company and the investors' points of view is the stability of the share price in the period immediately after the IPO. This criterion is the real test of the underwriter's ability to make the correct pricing, legally support the price of the share if needed (since underwriters are entitled to stabilize the price of the share a short period after the IPO), and successfully choose investors who will invest in the security based on long-term considerations. However, it should be kept in mind that an unusual plunge of the entire market or of the shares of comparable companies after the IPO could also cause the price of the share to be unstable, regardless of the underwriter's professionalism and ability to correctly price the share.

Selling the Shares to the Public and Closing

Closing is performed three to five business days after the underwriting agreement is signed. During this interim period, between the signing and closing of the underwriting agreement, the underwriters sell the securities to the investors who expressed an interest in them during the book building process. At closing, the company transfers the shares to the underwriters in consideration for the price determined in the pricing (i.e., the price to the public less the underwriters' discount). Various legal documents are also delivered at closing and an update (bring-down) of the comfort letter.

Trading, Stabilization, and Exercise of the Underwriters' Option (Green Shoe)

Trading in the share begins in the day following the effectiveness of the registration statement (which is one day following the pricing), in the stock exchange in which the underwriter listed the shares. According to U.S. law (Regulation M), the underwriter is allowed to support the price of the share after the IPO by creating a demand for the share. Strict limitations are imposed on the stabilization process, the main one of which prohibits the purchase of shares for more than their trading price (in order to prevent "stock running"). The stabilization is performed in practice by the managing underwriter, since only one member of the syndicate is allowed to engage in stabilization. The managing underwriter is also required to disclose the nature and scope of any stabilizing acts performed.

The purpose of stabilization is to ensure trade that is free of substantial volatility in price after the IPO and mainly to prevent unusual drops in the price. The price of the share may be supported in two ways: buying shares after the IPO in order to support the price of the share (if necessary), and selling investors, during the IPO, more shares than were actually allotted. If the share is expected to require stabilization after the IPO, such over-allotment can reach up to around 20% of the offering. However, this short position exposes the underwriters to the risk that the price of the shares will rise above the IPO price. This is one of the reasons why underwriters often incorporate into the underwriting agreement an option allowing them to buy from the company up to 15% of the offering for the IPO price, for a period of 30 days following the IPO. This option is known as a "green shoe," named after the first company in whose IPO this instrument was used. By exercising the option, the underwriters cover their short position and increase the offering according to the circumstances. Such an option may now be found in almost every IPO.



From Concept to Wall Street(c) A Complete Guide to Entrepreneurship and Venture Capital
From Concept to Wall Street: A Complete Guide to Entrepreneurship and Venture Capital
ISBN: 0130348031
EAN: 2147483647
Year: 2005
Pages: 131

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