Understanding IPOs

An “IPO” is the initial public offering by a company of its securities.  In an IPO, the company offers and sells stock, most often its common stock, through an underwriter. When a company cannot locate an underwriter, it may sell its own shares using a direct public offering (“DPO“). 

In the United States, these offerings are generally registered under the Securities Act of 1933, as amended (the “Securities Act”), and the shares are often but not always listed on a national securities exchange such as the New York Stock Exchange (the “NYSE”), one of the Nasdaq markets (“Nasdaq”) or the over-the-counter market (“OTC Markets”).  

Upon the completion of an IPO, a company becomes a “public company,” subject to all of the regulations applicable to public companies, including those of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).

What are the advantages of going public? 

• Raise Capital. The most obvious reason to go public is to raise capital. There are fewer restrictions when raising capital through a public offering versus a private offering. The funds received from the securities sold in an IPO may be used for common company purposes, such as working capital, research and development, retiring existing indebtedness and acquiring other companies or businesses. 
• Public Market. Going public creates a public market for a company’s securities. Liquidity is important for existing and future investors and may allow the owners and employees who receive stock through an employee benefits program to sell their stock more easily. 
• Access to Capital. Following an IPO, a company should have greater access to capital in the future. Once a public market is created, a company may use its equity instead of cash to acquire other businesses or avoid costly debt financings. 
• Increased Visibility. Public companies have greater visibility, creating more brand awareness, publicity and prestige for the company. Local and national media are more likely to report matters related to public companies than private companies, increasing recognition of the issuer.
• Growth Opportunity. Going public allows a company’s employees to share in its growth and success through stock options and other equity-based compensation. A public company may also use its equity to attract and retain management and key personnel.

What are the disadvantages of going public? 

• Costly Process. The IPO process is expensive, and these costs must be paid regardless of whether an IPO is successful. 
• Increased Expenses. Once an IPO is completed, a company will incur higher costs as a public company, including the significant compliance requirements of the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”) and the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank”). 
• Increased Scrutiny. There is much more public scrutiny of a company after an IPO. Once a company is public, certain information must be disclosed, such as compensation, financial information and material agreements.

What types of companies go public?

Going public is geared towards large companies and may not be a suitable strategy for smaller businesses under all scenarios. Any company seeking greater access to capital may decide to go public. Companies with revenues and profits or a shorter path to profitability are more likely to have successful IPOs than companies without revenues or in a development stage, particularly in difficult economic environments. A company seeking increased visibility and liquidity may also decide to go public.

The board of directors of the company should consider the advantages and disadvantages of going public and the company’s needs to determine if going public is in the best interest of the company and its shareholders.

When should a company go public? 

There is no right answer. It depends on a company’s need for cash or liquidity to pursue its strategic plans. 

Who is involved in an IPO? 

An IPO team will include a lead underwriter, potentially co-managing underwriters, an independent auditing firm with significant public company experience, outside legal counsel, a transfer agent, and a financial printer. A company may also want to hire a public relations firm. 

What does the managing underwriter do? 

A company will identify one or more lead underwriters responsible for the offering process. A company should choose an underwriter based on its industry expertise, including its overall reputation and the reputation of its research analysts. Depending on the size of the offering, a company may want to include several co-managers.

The underwriters will market the IPO shares, set the price (in consultation with the company) at which the shares will be offered to the public, and, in a “firm commitment” underwriting, purchase the shares from the company and then resell them to investors.

What do the auditors/accountants do? 

Accountants prepare and audit the financial statements of a company that must be included in an IPO registration statement. Other services provided by the accountants during the offering process include assisting a company in preparing the other financial portions of the prospectus, such as the summary financial information, selected financial information, capitalization and dilution tables, and any required pro forma financial statements, and working with the company to identify any problems associated with providing the required financial statements to seek necessary accommodation from the SEC. The accountants will also provide a “comfort letter” to the underwriters.

What does legal counsel do? 

A company’s in-house and outside legal counsel play essential roles in completing the IPO. A company’s counsel: 

• has principal responsibility for preparing the registration statement, prospectus, stock exchange application and any confidential treatment requests; 
• communicates with the SEC and the stock exchanges on a company’s behalf, responding to any comments they may have; 
• negotiates an underwriting agreement with the underwriters and their counsel; and
• prepares various other documents, including stock option plans, corporate documents, and required consents, waivers and legal opinions.

What role does the transfer agent play?

A transfer agent is the custodian of the company’s shareholder records, including purchases, sales, transfers and account balances.  After the completion of the going public transaction, as the company’s securities begin to trade actively, it becomes critical to have efficient transfer agent operations.

Choosing a qualified transfer agent that offers a reasonable fee structure and terms is an important yet often overlooked step in the process. 

What role do research analysts play? 

Generally, research analysts will cover the company once it becomes public, increasing the company’s visibility.

What are the periods of the IPO process? 

The public offering process is divided into three periods: 

• Pre-filing. The pre-filing period is the period from when the determination is made to proceed with a public offering to the filing of a registration statement with the SEC. This is also generally called the “quiet period,” and a company is usually subject to limitations on its public communications.
• Waiting or pre-effective. The waiting or pre-effective period is the period from the date of the filing of the registration statement to its “effective date.” During this period, a company may make oral offers and certain written offers, but may not enter binding agreements to sell the offered security.
• Pricing and post-effective. The post-effective period is the period from the date the registration statement has been “declared effective” by the SEC to the completion of the offering. 

SEC filing requirements in IPOs

The issuer must file a registration statement with the SEC in connection with its IPO. The registration statement will usually be on Form S-1, or Form F-1 if it is a foreign issuer.  After the registration statement is filed, the SEC will typically render comments. The issuer must respond to comments in a response letter and by filing an amendment to the registration statement.

A registration statement consists of two parts. Part I contains information about the issuer’s business and financial condition, including its audited financial statements.  Part II consists of information about the offering expenses and fees, indemnification of officers and directors, and a description of recent sales of unregistered securities.  Part II also contains the issuer’s legal undertakings and the exhibits to the registration statement.  It is provided to the public but need not be included in the prospectus.

The prospectus provides disclosures of the offering terms, the anticipated use of proceeds, the issuer, its industry, business, management and ownership, and its results of operations and financial condition.  The prospectus must include the following, as well as other information:

• Summary Information. The summary consists of the type of security being registered, a brief description of the issuer, the amount of securities offered, the trading market for the securities and the intended use of the proceeds.
• Financial Statements. The prospectus will include audited balance sheets for each of the last two completed fiscal years and income statements. The prospectus must also include unaudited financial statements for any interim periods after the last fiscal year.  These statements must be prepared in accordance with U.S. GAAP, and they will be the source of information for the management’s discussion and analysis section (“MD&A”).
• MD&A. The MD&A section describes the issuer’s liquidity, capital resources, results of operations and known trends and uncertainties.
• Plan of Distribution. This section contains a plan of distribution, detailing underwriting arrangements and underwriters’ plans for distributing the shares registered in the offering.
• Risk Factors. A risk factors section describes the specific risks attendant to the issuer, including risks of the offering, risks about the issuer and the issuer’s industry.
• Business Section. The business section describes the issuer’s business, products and services, intellectual property, location, employees, key suppliers, customers and marketing arrangements and plans.
• Management. This section identifies the officers and directors and includes a description of each, including biographies, education and other information.
• Executive Compensation. The company must disclose the executive compensation of its five highest-paid executive officers, which must include the CEO and CFO, as well as an explanation of directors’ compensation and employee benefit plans.
• Related Party Transactions. The company must disclose related party transactions, which include any material business transactions between the issuer and its executive officers, directors, significant shareholders, key personnel, founders and promoters.
• Security Ownership. This section includes a table of security ownership by the issuer’s officers and directors and the beneficial ownership of each holder of more than 5% of the issuer’s outstanding stock.
• Counsel and Experts. These two sections identify counsel to the company, the underwriters and the accountants who have audited the company’s financial statements. “Experts” will also identify anyone else who has “expertized” any information in the prospectus.

What is the SEC review process? 

The SEC’s review of the registration statement is an integral part of the IPO process. Once a registration statement is filed, a team of SEC Staff members is assigned to review the filing. The team consists of accountants and lawyers, including examiners and supervisors. The SEC’s objective is to assess the company’s compliance with its registration and disclosure rules. 

The SEC’s review is not limited to just the registration statement. The SEC Staff will closely review websites, databases, and magazine and newspaper articles, looking in particular for information that they think should be in the prospectus or that contradicts information included in the prospectus.

After its review, the SEC sends comments to the issuer and/or its securities lawyer concerning the disclosures made. The issuer must file an amendment to the previously filed S-1 registration statement along with a response letter to the SEC’s comments.  SEC comments may be lengthy and complex; it’s important that the issuer and its attorney compile the original submission with care, in order to avoid repeated exchanges with the SEC.

The SEC will review the response letter and the amended S-1 registration statement and send additional comments, if necessary.  The review of the S-1 Registration continues until the SEC staff is satisfied with the disclosure provided by the issuer and can usually last from two to five months. Once that happens, the SEC will declare the S-1 effective.

The S-1 must be declared effective before the issuer or any selling shareholder can sell the securities registered in the offering.

Form 8-A in the IPO Process

In addition to the Form S-1, the issuer often files a registration statement on Form 8-A to register a class of securities, typically its common stock, under the Exchange Act.  The Form 8-A subjects the issuer to the Exchange Act’s reporting requirements after a registration statement under the Securities Act.  An 8-A, which is a very simple form, will be required if the issuer plans to list on a national exchange.

For more information about IPOs or to speak with a Securities Attorney about assisting with your IPO, please contact Brenda Hamilton at 200 E Palmetto Rd, Suite 103, Boca Raton, Florida, (561) 416-8956, or by email at [email protected].

Hamilton & Associates | Securities Attorneys
Brenda Hamilton, Securities Attorney
200 E Palmetto Rd, Suite 103
Boca Raton, Florida 33432
Telephone: (561) 416-8956
Facsimile: (561) 416-2855
www.SecuritiesLawyer101.com