INITIAL PUBLIC OFFERING



An initial public offering (IPO) is the process through which a privately owned business sells shares of stock to the public for the first time. Also known as going public, an IPO provides a growing business with access to public capital markets and increases its credibility and exposure. It has long been considered a right of passage that marks an important phase in a business's development. At the same time, however, staging an IPO is both time consuming and expensive. It requires companies to navigate a complex Securities and Exchange Commission (SEC) registration process and disclose a great deal of confidential information to potential investors. Furthermore, the success of an IPO is not guaranteed, and depends in part upon industry, economic, and market conditions that are beyond a company's direct control. Overall, the decision to go public is a complicated one that requires careful management consideration and planning.

There is no doubt that becoming a public entity offers a number of advantages to a business. In addition to gaining immediate access to capital to fund expansion, it also makes it easier for the firm to obtain capital in the future. The IPO process provides a company with a great deal of publicity, which may help increase its credibility with suppliers and lenders, attract new customers, and create new business opportunities. Going public also offers an opportunity for the company's founders and venture capitalists to cash out on their early investments, and provides a public valuation of the company to facilitate future mergers and acquisitions.

Some of the major disadvantages associated with going public include the high cost of staging an IPO (which may claim 15 to 20 percent of the proceeds from the stock sale), the demands on the time of managers (the process may take between six months and two years to complete), and the dilution of ownership and associated loss of management flexibility and control. In addition, the process of going public requires a private company to disclose confidential information about its strategy, capital structure, customers, products, competitors, profit margins, and employee compensation. Finally, becoming accountable to shareholders sometimes leads to an increased emphasis on short-term financial performance.

The first step in the IPO process involves applying to the SEC for permission to sell stock and preparing an initial registration statement according to SEC regulations. This statement includes a prospectus of detailed information about the company, financial statements, and a candid management analysis of the risks and benefits of investing in the company. The next step involves selecting an underwriter—usually an investment bank—to act as an intermediary between the company and the capital markets. The underwriter helps determine the valuation of the company and the suggested share price. It also helps assemble an under-writing team, which includes attorneys, accountants, and financial printers.

While the SEC completes its review of the registration statement—a period of time known as the cooling off or quiet period—the company undergoes an audit by independent accountants, files forms with the states where the stock will be sold, and begins marketing the investment to potential investors through road shows featuring top executives. Once the SEC review is complete, the company finalizes the registration statement, files a final amendment with the SEC, and agrees to an asking price for the shares of stock. Then the sale of stock finally takes place, overseen by the underwriter. Afterward, the underwriter meets with all involved parties to distribute funds from the sale, settle expenses, arrange for the transfer of stock, and file final reports with the SEC.

The pace of IPOs peaked in 1999, fueled by investor interest in Internet-related businesses. It declined markedly in 2000, as a drop in the value of technology stocks led to an overall drop in the stock market. Over the next few years, investors largely adopted a more cautious, back-to-basics approach toward IPOs. They increasingly demanded that companies demonstrate a proven business model, solid management team, large customer base, and strong revenue potential if they hoped to stage a successful IPO. Another factor limiting the number of IPOs was the Sarbanes-Oxley Act (SOA) of 2002. Passed in the wake of several high-profile corporate accounting scandals, the act required the boards of public companies to include independent directors with financial experience. It also required public companies to form auditing committees chaired by an outside director. The SOA and similar regulations have made it more expensive for companies not only to go public, but also to be public, in the twenty-first century.

SEE ALSO: Cash Flow Analysis and Statement ; Due Diligence ; Entrepreneurship ; Financial Issues for Managers ; Strategy Implementation

Laurie Collier Hillstrom

FURTHER READING:

Evanson, David R. "Public School: Learning How to Prepare for an IPO." Entrepreneur, October 1997.

Kleeburg, Richard F. Initial Public Offerings. South-Western Publishing, 2005.

Quittner, Jeremy. "Private Matters: IPOs Move Further Out of Reach." Business Week, 1 November 2004.

Vallone, Paul. "IPO Checklist: Preparing Your Company for Public Markets." San Diego Business Journal, 23 February 2004.

Welch, Ivo. "IPO: The Initial Public Offerings Resource Page." Available from http://www.iporesources.org/ipopage.html.



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