IPO

An initial public offering, or IPO, is the very first sale of stock issued by a company to the
public. Prior to an IPO the company is considered private, with a relatively small number of
shareholders made up primarily of early investors (such as the founders, their families and
friends) and professional investors (such as venture capitalists or angel investors). The public,
on the other hand, consists of everybody else – any individual or institutional investor who
wasn’t involved in the early days of the company and who is interested in buying shares of
the company. Until a company’s stock is offered for sale to the public, the public is unable to
invest in it. You can potentially approach the owners of a private company about investing,
but they're not obligated to sell you anything. Public companies, on the other hand, have sold
at least a portion of their shares to the public to be traded on a stock exchange. This is why an
IPO is also referred to as "going public."

How Initial Public Offering Works?

An IPO is not only an indication that a private company needs more capital to fuel its growth;
it’s also a symbol that the business has made their mark in the world map.

Not all businesses go for an Initial Public Offering. Only few who feel that they are
competitive enough to go big, only go for initial public offering. But IPO is not all a bed of
roses. With the recent Sarbanes-Oxley Act (in 2002), IPO has become an arduous process
which not only cost the business more money; but also more regulatory requirements which
very few company can crack.

Having said that, there are the following steps you need to take if you would like to take
your private company to public–

1 – DECIDE WHY YOU ARE GOING FOR AN IPO

We know that the reason you are going for an Initial Public Offering is to raise money. But
why you want to raise money? Do you want to expand your business? Do you want to go
for backward integration or forward integration? Do you want to diversify your business? No
matter what reasons you have, count them in and go to the next step.

2 – HIRE AN INVESTMENT BANK

Once you have clarity on why Initial Public Offering is an essential option, the next step is to
find out an investment bank which can work as an underwriter for your IPO process. This
step is critical. Because there is a lot that depends on the investment bank. So before selecting
the bank, choose whether the bank has any previous record of conducting an Initial Public
Offering. Having experience in conducting IPO will take away a lot of burden from your
shoulder.
3 – THE WORK OF THE UNDERWRITER

Once the investment bank is hired, it acts as an underwriter. The underwriter decides the
value of the company and how much investors are willing to pay for shares in the company.
After that, the initial public offering (IPO) is planned out and at pre-decided price company’s
shares hit the stock market. Then the individual investors will purchase shares and the
company will get news funds. The entire transaction is first funded by the investment bank so
that company has enough funds before the IPO.

4 – Thoughts on contrast

IPO process usually takes months to complete. And in some cases, Initial Public Offering is
not always successful. Who will need to bear the cost then? The sad part is even if Initial
Public Offering becomes unsuccessful, the cost has to be borne by the company and it usually
costs them around $300,000 to $500,000. The cost needs to be incurred for printing, legal
matters and accounting fees etc.

5 – DUE DILIGENCE

If you want to make your Initial Public Offering successful, first go in the market and find out
whether your idea of expansion or diversification is a great idea. Ask your customers. Find
out from the competitors. Primary research is much more important than secondary research.
So invest first in primary research and record your findings. Then compare the findings with
secondary research and see whether you can see any trend. If yes, follow along. If not, go
deep and find out more. Due diligence is critical for your IPO because it will ultimately
decide whether the IPO would be successful or not.

6 – PLACES TO GO PUBLIC

After all this preparation, it’s time to know where you will go public, i.e. stock exchanges.
There are few options for you. First is, of course, NYSE (New York Stock Exchange). There
is also AMEX (American Stock Exchange). You can choose NASDAQ (National Association
of Securities Dealers Automated Quotations) as well. Other options are OTCBB (Over the
Counter Bulletin Board) and the Pink Sheets. Depending on the need of the hour you can
choose what stock exchange will suit you. For example, many start-up companies choose
Over the Counter Bulletin Board and the Pink Sheets because there is no requirement for
asset or revenue. As they grow in revenue and asset, they grow up the ladder and choose
higher rung.

Example of IPO Process

We can pick up any great company and tear the facts up to see what worked for them and

what didn’t. Let’s take Facebook and dive in.

 Facebook Initial Public Offering is one of the biggest IPOs ever. On 1st February,

2010, Facebook filed for an IPO by their S1 document with Securities and Exchange
 Commission (SEC). Their prospectus showed that at that time they had 845 million

monthly users with over 2 billion likes and comments daily.

 After the IPO, Mark Zuckerberg retained 22% of ownership share and 57% of voting

shares. At the time of IPO, they wanted to raise $5 billion. The valuation went weary

at times as many pundits gave many valuations. Ultimately Facebook shares were

priced $38 per share which is more than its target range. At that price, Facebook was

valued $104 billion. It was the largest valuation till date in the history of newly public

company.

 The Initial Public Offering of Facebook occurred on 14th May, 2012. On 16th May,

Facebook announced that they would sell 25% more of their shares due to huge

demand. This has helped Facebook debut with 421 million shares.

 At the end of the week, Facebook closed its Initial Public Offering at $26.81 per

share. Its PE ratio was staggering, a whopping 85 in spite of reduced revenue and

earnings in the first quarter of 2012.

 CASE STUDY

The Twitter IPO

“One deal that interested me recently was Twitter’s $1.8 billion IPO.

Twitter, a major social media company everyone knows, had around $317 million in
revenue and a net loss of $80 million in its last fiscal year prior to IPO, and in its current
fiscal year so far, sales have increased nearly 80% but the net loss has also increased.

Twitter decided to go public because of the favorable market environment and its
growing size – the company could raise funding at an attractive valuation that let insiders
and investors reap their gains while also giving the firm enough funds to continue growing
its business.

Twitter priced at $26.00 per share, which valued it at around 12.4x forward revenue. That
was in-line with Facebook’s multiple of 11.6x and LinkedIn’s multiple of 12.2x at the time.
Although those multiples are extremely high and unheard of for non-tech companies, the
valuation wasn’t completely ridiculous since the comps were in a similar range.

After the IPO, however, Twitter’s shares surged almost 73% in the first day and even went
over $70.00 before falling back closer to $60.00 in the months afterward.

In my opinion, the original valuation at $26.00 share was reasonable, though still very rich
compared to other industries, and a good deal for both new and old investors.

The valuation since the IPO, however, has grown far too high and it’s likely that the price
will decline once again, especially if Twitter misses revenue, earnings, or user growth
expectations.

It’s a good example of a ‘Great company, but not a great investment at its current price’
story.”

Commentary: The background information here is very brief because everyone knows
Twitter, but we do at least mention the industry, revenue, and net income figures.

The most important part is that we cite the multiples of peer companies and use those to
show how the initial valuation was not that ridiculous – but how it became overvalued
afterward as silly retail investors hopped on board the train, unknowingly headed into a
large black hole.

EV / EBITDA and P / E multiples do not apply since the company was unprofitable, so we
cite revenue multiples instead (which is, itself, another sign of an overvalued company).

You could get all this information from 2 mainstream news articles, with no further work
required: Bloomberg and Business Insider.