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We often hear about companies going public, which causes a commotion in the market and often becomes the talk of the country. Every Tom, Dick and Harry speculate about the IPO even when they don’t know what they are talking about. Maybe you find yourself in such conversations and don’t have much to offer to the conversation, or you just want to know what going public means so that you can invest in one. Perhaps you have a corporation you might like to take public someday, either in NASDAQ (US market) or TSX (Canadian market). Either way, this blog will help you learn how private companies go public.
The way an IPO works for a corporation and an investor is completely different. A corporation may reach a particular valuation stage (typically when a company becomes a unicorn) or qualify specific criteria (profitability, strong fundamentals, etc.) and decide to go public.
For an investor, an IPO is an opportunity to invest in a company that gives them returns in the future. Thus, they need to read the prospectus, keep an eye on the news, look for any significant investment firms that plan to invest in the company, analyze the company's fundamentals, and its technicals to ensure that their investment gives them fruits later.
Airbnb listed its IPO on NASDAQ on December 10 2020, where each share was priced at $68 and successfully raised $3.4 billion. Now, they will use the money raised to better than business to give back to their investors. Thus, the number one reason companies go public is to raise money to grow their business.
Some other reasons companies go public are:
All of the above reasons motivate a company to go public, but how does it even begin going public? Even though IPO is not the only way of going public (we have discussed other ways of going public in the next section), the most popular way of going public is via an IPO and here is how one proceeds with an IPO:
Proposals: The first step involves underwriters laying the groundwork for the IPO and discussing the offering price of each share, the number of total shares they want to release, the security they will issue, and an estimation of the period of market offering.
Team: Team formation with legal entities, underwriters, CPAs, and SEC experts to guide the company with the process.
Documentation: The issuer prepares an S-1 registration statement with the prospectus (the one investors will read and decide to invest or not) and privately held information. However, constant revisions will keep happening pre-IPO.
Marketing: Well, one has to market that they will be going public to gather enough investors for a successful IPO. Thus, the companies start marketing, and according to the response, some more changes are made to the offering price and launch date.
Board & processes: After the company goes public, there will be a change in the company's finances, and thus a board of directors is formed along with processes for reporting the necessary information each quarter.
Shares issued: On the day of the launch, the company issues the shares, and people start buying the shares. The money collected from this is noted as shareholder’s equity.
However, an IPO is not the only way to go public. The following section discusses ways other than IPO that companies may use to go public.
Direct listings are the way of going public without selling your stock a share of the company. The problem with an IPO is that it is expensive. Thus, prominent companies with brand recognition decide to take the route of direct listing to go public without the expense. But why doesn’t everybody go for direct listing? Well, it's because many companies want immediate cash and do not have name recognition in the market. Thus, they prefer IPOs, or an alternative called SPAC.
SPACs is the way of going public where many investors create a blank-check company in the industry they want to invest in and use this company to acquire other companies. The blank-check company goes public, and then it acquires a private company. The private company becomes a public company, and thus they avoid the expensive IPO route.
In an IPO, you cannot make future revenue projections which makes it difficult for companies that are pre-revenue to go public. But with SPAC, your target company can make the future projection to raise the funds it needs. Whereas SPAC is the USA version of going public, its Canadian counterpart is a capital pool company (CPC). The TMX group was the one that created this system, and the companies that go public via this route trade on the TSX venture exchange.
Another way of going public is a private placement where the company doesn’t sell the shares to the public and instead sell them to selected investors or organizations. The investors are either banks, financial institutions, individual investors, etc. Companies prefer this way due to few regulations.
Abridged prospectus: It is the compulsory shorter version of the IPO prospectus.
Draft red herring prospectus (DRHP): It is a draft prospectus where companies submit to the SEC in the US and OSFI in Canada that the regulatory council makes changes accordingly.
Red herring prospectus: The final prospectus that the regulatory council approves and the one that the public can refer to make their decision to invest in the IPO or not.
Price band: The company and the underwriter set a price range between which the investor can bid.
Book building process: After the investors invest, this process will decide the IPO’s issue price. If the bid was higher, the issue price would be closer to a maximum price and vice versa.
Offer Date: Offer date is the first date of bidding on the IPO.
Not everybody can go public, and thus here are the criteria they need to pass before going public.
An essential part of going public is the investors. But, how do everyday investors keep track of these IPOs? These are a few tips and tricks you should keep in mind when you see an attractive IPO.
Finding IPOs: Not every company that goes public will make the news, and thus the first step as an investor is to find IPOs. Therefore, create IPO watchlists and keep track of the market to catch an IPO. After you find an IPO, read its prospectus, and analyze its fundamentals to ensure it is a long-lasting company with the potential to grow (and increase your share price). Use these resources to make your watchlists.
Companies’ social channels: Another great way to know about new IPOs is by following the company’s social channels. Follow the companies' social media on your watchlist to not miss out when they announce their IPO.
Newsletter: newsletters are a great way of following the companies on your watchlist. Since newsletters are one of the most important marketing channels, subscribing to them and keeping up with them is a great way to learn about IPOs first.
Media companies: Now we see super-niche media companies that talk about niche companies. Thus, follow these media companies to get alerts regarding IPOs. You may also come across IPOs of the company's competitors in your watchlist, which will help you come across new companies in the same industry.
Buy the stocks in an IPO: After doing your due research, buy the stocks on the offer date of the IPO. Always keep a calendar alert for the start and end of the IPO to not miss out.
For retail investors or high-net-worth people, brokers and hedge funds can help you with pre-IPO access. Moreover, we discussed private placements as another way of going public that involves only firms and individuals who can invest more.
To conclude, we discussed how an IPO works for a company and an investor. Why do companies go public, and what are various ways of going public apart from IPOs. We also discussed some related terms to an IPO, and the criteria company must pass before going public. Finally, we discussed how investors can get involved in the process of companies going public.