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What is an IPO? Demystifying the process




3 min read

Finance is full of acronyms and jargon, and Initial Public Offerings (or IPOs) are no different. In this article we do our best to demystify the IPO process, or how a company becomes public. An IPO is when a company offers its shares to the public for the first time on a public stock exchange such as the Main Market of the London Stock Exchange (LSE)

It can take up to a year of preparation to get a company ready and then two months or so of marketing. But what does the company do during this time and why is it necessary?

All forms of finance concern access to capital and an IPO gives a company access to a very deep pool of capital through public market investors. However, to be given this access a private company needs to change the way it looks, the way it feels and the way it acts. If it does this satisfactorily, the stock exchange will grant it a listing and public investors will be able to buy its shares.

The two phases of an IPO process:

1. The preparatory phase (lasting from four months to one year):

The preparatory phase gets the company ready to be a public company from the corporate governance, budgeting, working capital, personnel, IT systems and PR/IR perspectives. This might involve new hires, and changes to lots of systems and controls. The company also appoints several advisors (at some expense). One of these – the investment bank/broker – will help the company understand how much it might be worth and how much it might be able to raise. The investment bank might also introduce the company to a select group of investors (normally between five and 20) to gauge interest.

The company and its advisors will draft all the marketing documents, one of these being the Prospectus, which contains all the information necessary for investors to make their investment decision. All investors get to see the Prospectus ahead of investing.

2. The formal marketing phase (typically lasting four weeks):

Public company shares have a market­derived price based on publicly available information: information that has been disclosed by the company, reported by analysts, and all sorts of macro and sector data.

As private companies have limited disclosure obligations, financial analysts do not cover them and, more often than not, the press does not pay them a great deal of attention. The aim of the marketing phase is to get as close to an equivalent market derived valuation as possible.

Once the company is fully prepared and the Prospectus is in advanced form, the formal marketing phase of the IPO kicks off with the publication of the Intention to Float announcement. At the same time, the investment bank’s research analyst publishes their research note and circulates investor contacts.

IPO process Infographic, explaining what is an ipo

Principal parties involved in an IPO

The company: The company (or the issuer) offers its shares to investors.

The investor: Public market investors can be institutions or individuals.

The underwriters/investment bank: An investment bank appoints the company’s shares to institutional investors. It also underwrites and takes up any shares for orders that are not honoured by the investors. The investment banks also run the IPO process.

Research analysts: The investment bank appoints an individual research analyst to cover the company at IPO and beyond. The research analyst meets management at an analyst presentation and writes research notes that they send to investors at the start of the marketing period.

The research note covers key investment themes, risks and valuation methodology. The research analyst also writes about the company after IPO, which canhelp the company’s profile lawyers.

Profile lawyers: The company and the investment bank have their own lawyers to help draft the Prospectus. Both sets of lawyers sign off on the content of the Prospectus, and negotiate key agreements between the company and the investment bank.

Auditors: The auditor audits the historical financial information that appears in the Prospectus (typically going back three years).

Settlement and beyond

Following settlement, the company and investors want to see a small rise in the share price, which demonstrates that the company has been properly valued and that the right investors have been allocated to.

Most companies will want to raise capital at some point post IPO. To do this effectively, a company will need a strong group of supportive shareholders. To develop this group, the company must ensure that it hits its promised targets, which were made during the marketing process, and that it reports in a timely and transparent manner on an ongoing basis.

An IPO is an important step for a company, but it is the first step in the public markets. All this preparation and marketing ensures that at IPO the company is well positioned to succeed on the next stage of its development.

Want to learn more about IPOs? Download our free guide today

 

How to invest in IPOs Guide cover

 


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