IPO (Initial Public Offering) – How Companies are Valued and Listed

IPO (Initial Public Offering) – How Companies are Valued and Listed

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An Initial Public Offering (IPO) is the first sale of stock. What is a Stock? The person who owns stock in a company is called a shareholder and has the right to claim a portion of the company’s remaining assets and earnings (if the company is dissolved). 

The terms “stock,” “shares,” and “equity” are used interchangeably disclosed to the public by a company. 

Before IPO, a company is considered a private company, usually few investors (business investors such as founders, friends, family and venture capitalists).

Venture Capital is a form of financing that provides early-stage funding, High in exchange for stock or ownership interest start-up companies with growth potential. 

Venture capitalists take the risk of investing in startup companies in the hopes of generating substantial returns when companies succeed. 

An angel investor can be a person or a company that gives funds or capital to the early-stage startups in exchange for the company’s equity. 

They can provide a one-time investment or an ongoing capital injection to help the business get through the difficult early stages). 

When a company goes public, the general public can buy shares quickly and own part. 

An IPO is often referred to as an “IPO,” and an investment bank typically manages the underwriting process. 

IBD – Investment Banking Division IBD is an acronym for Investment Banking Division within the general investment bank. IBD is responsible for working with companies, institutions and organizations.

Initial Public Offering

Reasons for Companies to Go Public

Companies looking to grow often use Initial Public Offerings to raise capital. The most significant advantage of the IPO is the additional capital raised. 

Capital raised can be used to purchase additional property. Plant and equipment PP&E (Property, Plant and Equipment) PP&E (Property, Plant and Equipment) is a critical fixed asset on the balance sheet. 

PP&E is affected by Investment Expenditures, Depreciation and Acquisitions / Disposition of Fixed Assets. 

These assets play an essential role in the financial planning and analysis of a company’s operations and future expenditure (PPE), funding research and development (R&D), expanding or paying off existing debt. 

There is also a growing awareness of a company through an IPO, which typically generates a wave of potential new customers.

Additionally, private investors/co-founders/venture capitalists can use an IPO as an exit strategy. 

For example, when Facebook went public, Mark Zuckerberg sold approximately 31 million shares worth $1.1 billion. An IPO is one of the most common ways for venture capitalists to make substantial money.

The most important reason to go public… to raise money!

Initial Public Offering (IPO) Steps

The first step in an Initial Public Offering is to hire an investment bank or bank to handle the IPO. Investment banks can work with someone taking the lead, or a bank can operate alone.

Then, everyone involved in the IPO — the management team, auditors, accountants, insurer banks, attorneys, and the Securities and Exchange Commission (SEC) experts — attend a meeting to discuss the proposal and determine the time for filing.

Similar meetings take place throughout the entire underwriting process.

After the meeting, due diligence is required at the company to ensure that the registration statements are correct. Duties include market due diligence, legal and IP due diligence, financial and tax due diligence.

The final result of due diligence is the S-1 Registration Statement. Information in the disclosure includes historical financial statements, fundamental data, company overview, risk factors and more.

A pre-IPO analyst meeting is organized after the S-1 Registration Statement is issued to the bankers and analysts about the company. 

The Bankers and analysts are also briefed about how the investors will buy the company. A preliminary prospectus can also be prepared.

Premarketing determines whether institutional investors like the industry and the company and the price they are willing to pay per share. 

The banks determined a price range for the supply and replaced S-1 Registration Statement with a price range connected with the internal valuation.

After the pre-marketing work and the S-1 Registration Statement are complete, the management team travels around to meet investors and market the company. 

It is an essential process as orders are set for the number of shares and the price that investors are willing to pay. 

The management team will meet with investment banks to decide the deal’s final price based on orders. 

If there are too many orders (excessive demand), the company will price the shares higher.

Once the IPO is priced, investment banks will allocate shares to investors, and the stock will begin trading in the market for the public to buy and sell.

Angel-Investors

Challenges Caused by a Public List

While going public has its benefits, there are also significant drawbacks to consider. An Initial Public Offering (IPO) may take up to six months to a year. 

During this time, the company’s management team will likely focus on the IPO, creating the potential for other business areas to suffer.

In the United States, publicly traded companies are monitored by the Securities and Exchange Commission (SEC). 

Public companies consist of thousands of shareholders and are subject to rules and regulations. Quarterly some of the board of directors should set and audit the finance and give the accounting information. 

Going public is an expensive process, so historically only private companies with solid fundamentals and high profitability potential go through an IPO. 

Finally, a public company’s information is readily available online, which can be helpful to competitors.

Company Valuation

What do Investment Bankers do? The Investment bankers can work up to 100 hours doing financial modeling, research and making presentations. 

Despite holding some of the most admired and financially rewarding positions in the banking industry, investment banking is also one of the most challenging career paths.

Guide to IB spends a lot of time trying to value the company’s going public. Ultimately, investors will decide what the company is worth when choosing to participate in the offering and buy and sell shares after being helpful listed on the stock market.

Here are the main methods bankers use to evaluate the company before going public:

  • What is Financial Modeling? Financial modeling is performed in Excel to predict the financial performance of a company. 
  • The Comparable Company Analysis means comparing other businesses in the same industry. 
  • Benchmark Transaction Analysis Peer Transaction Analysis is a company valuation method in which past M&A transactions are used to value a similar business today. Commonly referred to as “peer-to-peer,” this method of valuation is often used by analysts to value an entire industry as part of a merger/acquisition.

By combining these three methods, bankers can triangulate what they think is a reasonable value that an investor would be willing to pay for the business.

A valuation can be more of an art than a science, and as such, many IPOs have a lot of volatility in the first few days of trading.

Initial Public Offering (IPO) Low Pricing

Angel Investors pitch deck

Despite all the valuation work mentioned above, there is still a tendency for low IPO pricing to occur when companies go public. 

For example, LinkedIn Corporation went public at $45 per share but went up to $122 at the end of the day. It is often called “leaving money on the table.”

Underwriting an IPO can be disastrous for a company. Suppose Company A prices its one million IPO at $20 per share. 

If the shares start trading at $40 per share, this indicates that Company A received $20 million ($1 million * $20) even though it could have earned $40 million ($1 million * $40) if the IPO was not underpriced.

A popular theory of why public offerings are underpriced in corporate finance can be illustrated by the following example:

Suppose there are two categories of investors investing in an IPO – insiders and the rest of the market (outsiders). 

Insiders know the actual.” value of the company and stay away if it’s overpriced. If the IPO is low-priced, insiders will buy the shares.

Outsiders don’t know the actual value of the company, but insiders know they do. With this knowledge, outsiders will follow the action of an insider:

  1. If the price of the IPO is low, everyone buys shares.
  2. If the IPO is overpriced, insiders won’t buy. Knowing this, foreigners will not accept the votive either.

It is, therefore, in the interest of the issuer and its bank to underprice the offer.

Other resources

Thank you for reading this guide to understand the initial public offering underwriting process! Finance’s mission is to help you advance your career.

FAQ

What is Equity Capital Markets?

Equity Capital Markets (ECM) The equity market is a subset of the capital market in which financial institutions and companies interact to trade financial instruments.

What are the Valuation Methods?

Valuation Methods There are three main valuation methods used when evaluating a company as a going concern: DCF analysis, comparable companies, and peer transactions. These valuation methods are used in investment banking, equity research, private equity, corporate development, mergers and acquisitions, leveraged buyouts and financing.

What is Financial Modeling?

Financial modeling is performed in Excel to predict the financial performance of a company. 


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