Forming the IPO Team

At first, after the company concludes its internal organization (see the section on preparing the company for an IPO in Chapter 12), an IPO team has to be established. This team includes, in addition to the company's management (CEO, CFO, and legal counsel), underwriters, outside legal counsel, CPAs, a financial printer, and sometimes also a PR firm.

The Underwriters

Underwriters play a central role in the sale of the shares in the IPO and thereafter. The underwriters are responsible for determining the IPO price, executing it, and distributing it among investors. The underwriters also play an important role in rendering advice on the structuring of the transaction, the timetables, and the manner of presentation of the information. The relationship with the underwriters does not end in the IPO, but rather begins there. The underwriters support the price of the share after the IPO (if necessary), provide coverage for the share through the bank's equity research department (which is separate from the underwriting department), and provide additional investment banking services to the company later on. The process of choosing the underwriters includes meetings with several underwriters and choosing a lead, or managing underwriter, which will be committed to the share. There is usually one lead underwriter or more (up to three) which manages the syndicate of underwriters and co-managers.

Investment banks offer companies a wide variety of financial services, including raising of capital (either shares or debt), market making and share trading, research coverage (analysts) and M&A and other financial consulting. The term underwriter refers to the underwriting, or corporate finance, arm of investment banks. The underwriters are the main players in the IPO process, and they accompany the company through the preparations for, during, and after the IPO.

Choosing the Underwriters

In most U.S. IPOs, the company undertakes a meticulous search before choosing the investment bank which will act as its group of underwriters. In some cases, the group of underwriters (the syndicate) is managed by a single investment bank, but in large IPOs it is customary to have two or three banks manage the offering. In addition, co-managers (syndicate members) are chosen, the number of which depends on the size of the IPO. When choosing the underwriters, the following issues need to be taken into consideration:

  • Reputation and experience The underwriter must have a good reputation in the community of investors and among companies which used its services. The underwriter serves as the gate keeper, and the market's preliminary disposition to the company is derived to a great extent from its underwriters' standing in the market. In addition, the first analyst-coverage is usually provided by the investment banks which were involved in the IPO. Lead underwriters are chosen based on the bank's underwriting reputation in the relevant field and its general underwriting expertise.

  • Commitment to the IPO The underwriter must be prepared to dedicate the appropriate attention and manpower to the planned IPO and to be committed to the company and the share after the IPO. A material element of the bank's role is to provide broad coverage for the share and to support it after the IPO, since without such deep commitment, it would be difficult for the company to gain recognition among investors and to increase its value. Commitment to an IPO, unlike reputation, is difficult to assess before the offering, but the experience of comparable companies with the same underwriters can nevertheless be used.

  • Distribution ability The underwriter's ability to successfully sell the IPO and place the shares in the hands of the right investors has a vast effect not only on the success of the IPO, but also on the share's future performance. The lead underwriter must organize a syndicate of underwriters to distribute the shares and to create the right composition of institutional and individual investors. Many underwriters specialize in different segments of the market, and it is important for the company that a delicate blend of these populations be created. That distribution will have implications on the liquidity and volatility of the share price, both immediately after the IPO and down the road.

  • Market-making and share-coverage capabilities An underwriter must cover the share and attract much interest to it in the secondary market after the IPO. When issuing on NASDAQ, an underwriter who will commit to act as a stock's market maker is essential. In most cases, the syndicate managers also act as the share's market makers after an IPO on NASDAQ, and they handle 40-50% of the volume of activity in the company's shares. The underwriter's equity research department and the coverage it provides for the share are highly important. A research department which has leading analysts in the company's field of activity, together with the underwriter's commitment to cover the share, will greatly increase the stock's visibility.

    The banks' regulations require that a "Chinese Wall" be erected between the underwriting and equity research departments in order to reduce the cases in which research reports are affected by the bank's underwriting relationships with the companies. Many studies indicate that this independence is not necessarily maintained, but sophisticated investors know how to neutralize these effects when making investment decisions.

  • Ability to provide additional services after the IPO The underwriting department is only one of the departments in an investment bank. The bank's ability to provide additional services to the company, including additional funding, M&A advisement, and finding deals should be examined.

  • Payment The payment received by the underwriter in consideration for its work is based on the difference between the price at which it buys the shares and the offering price. In an IPO, the standard "discount" is around 7% which is divided between the costs of preparing for the IPO, the actual IPO, and the road show. It should be understood that this figure differs from one offering to another according to the type of the company, the size of the offering, and the price at which the underwriter expects to be able to offer the shares (see the more detailed discussion of the payment structure later in this chapter).

The Underwriting Syndicate

Offerings in the United States are almost always performed by a syndicate of investment banks led by a lead underwriter. The tendency to assemble syndicates is derived from the underwriters' desire to spread the risk involved with the IPO among several underwriters and from their desire to achieve maximum distribution. Nowadays, with the increase in the size of the leading investment banks, almost every one of the leading investment banks could assume the major part of the underwriting and distribute the entire IPO alone (although this is not the common practice). The lead manager, or in many cases the co-managers or joint managers, manage the "book of orders" of the IPO. The lead manager is responsible for deciding how to divide the securities among the other underwriters. The decision of how to allocate the securities among institutional and private customers is reached in cooperation with the sales people, and the securities allotted to each underwriter are divided among the several types of target populations. When making the decision about the allotment, the lead managers take into account both short-term considerations, i.e., creating demand for the offered shares and being able to meet such demand, and long-term considerations, including creating demand for the company's shares in the long term and maintaining the stability of the share price.

Underwriter Compensation

The division of the underwriters' commission among the syndicate members changes from one offering to another, but usually follows these lines: The lead managers receive 20% of the commissions; another 20-30% is divided among the other underwriters for the underwriting risk (namely, the risk that the shares will not sell in the IPO), the division being prorated according to the underwriting commitments (i.e., the number of shares which each underwriter undertook to sell); the remaining commissions are sale commissions which are divided among the underwriters according to the actual sales of the shares and do not necessarily correspond to the underwriting undertakings. This division is determined by the order book managers. In most cases, the vast majority of actual sales are made by the underwriters' syndicate managers.

The managers' management fees are paid for preparing the IPO, which includes the following: due diligence; coordinating the road show; pricing the IPO, which involves a close scrutiny of the company's value according to its financial data and of the condition of the market at that time (see the section on pricing, signing the underwriting agreement, and registration statement effectiveness); and having the offering registered in the various states by the bank's legal counsel. The underwriting commissions do not include the company's IPO costs such as advertising, legal counseling and various marketing expenses, but only the underwriters' related expenses.

The Legal Counsel

The outside legal counsel has to be very experienced in working opposite the SEC and must be intimately acquainted with the IPO process. The legal counsel drafts the registration statement (the prospectus) and gives advice on complying with all the securities laws and regulations which govern the IPO process. The legal counsel also acts as the coordinator in the process of writing the prospectus and in the dialogue with the SEC. Choosing reputable and experienced firms which can also provide services on auxiliary issues (labor law, intellectual property, environmental law, etc.), and not only on securities issues, is advisable. The underwriters also use outside legal counsel, whose role is to draft the underwriting agreements, to ensure that the registration statement meets the securities rules, to perform the legal due diligence process, and to handle the comfort letter from the CPAs (see below).

The CPA

The CPA's functions include the following:

  • Preparing the financial statements The CPA, together with the company, prepares financial statements according to U.S. GAAP. Foreign companies can prepare financial statements according to the accepted accounting rules in their jurisdictions of incorporation, but these statements must be reconciled to the U.S. GAAP either fully or partially, depending on the registration mechanism. The independent auditor also audits the financial statements included in the prospectus, and his opinion is attached to the prospectus.

  • Adjusting the registration statement to the financial statements The CPA also takes part in preparing the parts of the prospectus which are based on the financial statements and verifies that all the financial data in the prospectus is supported by the information contained in the financial statements.

  • Providing the underwriters with a comfort letter The underwriters will not sign the underwriting agreement without a comfort letter from the CPA. This letter confirms that the statements are complying with U.S. GAAP and the SEC rules; that the data in the registration statement conform to the financial statements; and that they describe any material change which occurred since the end date of the last statements attached to the prospectus.

The CPA must be approved by the SEC as one who is authorized to work opposite it. Although this is not required by the SEC's rules, companies usually choose one of the large CPA firms, since many players in the market attribute a great deal of importance to the reputation of these firms.

The Cost of an IPO

The difference between the IPO price per share and the price per share received by the company (the gross spread) reflects the management fees, the underwriters' costs, and the distribution costs. This difference averages around 7%, but it depends, among other things, on the volume of the offering. In addition, companies have to bear other direct costs related to the listing of the shares, the printing of the prospectus, the legal advice provided by the company's counsel, and the CPA's audit. Some of these costs are fixed and some depend on the size of the offering. The total cost to the company of an IPO in the United States is approximately $1 million (excluding underwriters' commissions), most of which is paid to outside advisors and to the authorities, and some of which is attributable to internal costs within the company.



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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