This is a definitive guide about Initial Public Offering (IPO)
Here you will learn;
- what is an initial public offering (IPO),
- purpose of IPO,
- how IPO works,
- IPO team and processes
- IPO versus secondary offerings
- IPO examples
- Why lawyers are necessary for IPO
- Initial Public Offering Process
- Initial Public Offering Advantages
- Initial Public Offering Shortcomings
- Initial public offering versus secondary offering
Let’s get started
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What is an Initial Public Offering?
An initial Public Offering represents the first issue of the securities of a company to the public.
It is an act where a company is offering its stock on a public stock exchange for the first time.
Further IPO entails the legal processes through which a private company becomes a public company by offering its shares to the public.
In IPO the company which offers its share to the public it’s called an Issuer
Purpose of an IPO
The main purpose of the IPO is to raise capital by letting other investors invest their money into the company in exchange for dividends.
How IPO works?
IPO works as a legal means to validate the company to operate as a public company.
For example, A and B Co. Ltd operates as a private company.
Later on, they find the need to expand their entity thus they choose to convert to a public company.
Among other things, before starting to operate as a public company they must do IPO to comply with the legal requirements of a public company.
The law does not allow private companies to issue shares to the general public. Only a public company is allowed to do so.
Thus, whenever the company is converting from a private company to a public company it must do IPO to validate its conversion.
Alternatively, a company may wish to start as a public company from the beginning (which is very rare). To legally operate as a public company it must do IPO.
IPO Versus Going Public
Going Public is a term that is also commonly used to refer to the IPO Process. Once going public, the company’s shares may later be listed on a Stock Exchange.
The first company in world history to do an IPO and become a public company formally listed in the stock exchange is the Dutch East India Company in March 1602
According to the Museum of American finance, the first IPO in The US was the public offering of the Bank of North America around 1783.
Example of IPOs
The following are the 11 examples of IPOs that are reported by different sources to be the largest IPOs (based on the money raised) in the world.
The Alibaba Group
Agricultural Bank of China
Industrial and Commercial Bank of China
American International Assurance
The process of going public is thus a landmark transformation for any company.
Most of our companies at present are private companies, while some of them are statutory corporate bodies.
Hence, when such an entity decides to go public, it undergoes a momentous process of change in which it transforms itself in a variety of ways.
This requires the involvement of a range of actors and professionals.
The following diagram will help illustrate this point:
Why lawyers are necessary for IPO
The need for involving a lawyer in the process of going public is both a statutory requirement as well as a practical necessity.
For example, in Tanzania, the Capital Markets and Securities (Prospectus Requirements) Regulations, 1997, specify, among other things, the information required to be included in the prospectus.
This information includes an item called “Legal Opinion” which contains statements that, by law, must be given by a person qualified to practice law in Tanzania.
On the other hand, there are practical reasons for having a lawyer involved in the IPO process.
The mere fact that the process involves a legal transformation necessarily implies the operation of legal rules.
Like in any other important transaction in the world of business today, conditions exist that create demand for a person to learn and experience the application of legal principles and in handling complex legal issues.
Hence, a company intending to go public cannot do so without the aid of a legally trained mind.
Apart from the legal requirement, the nature of the work to be performed necessitates the lawyer’s involvement as can be seen in the following diagram:
Role of lawyers in IPO
Generally, lawyers play the following role when it comes to IPO.
To ensure that the issuing company is duly constituted as a public company:
- Minimum number of shareholders
- Free transferability of shares
- Absence of exemption rights
- Invitation to the public to subscribe is not prohibited.
2. To ensure that the necessary authorization to go public has been obtained
- Corporate Resolution
- Government authorization
3. To ensure that the company is in compliance with various legislations.
- Insurance covers
- Specific legislation
- Registrations (if any)
4. To deal with any litigations which pose a threat to the company’s revenue
5. Authentication of documents
6. To deal with the stricture of shareholding
- Ordinary shares
- Preference shares
7. Preparation of various Agreements for the company such as underwriting agreements (if any); engagement of other employees etc
8. To conduct due diligence to expose the risks, strengths, and weaknesses of the company
9. To prepare Declaration by Directors – statement
10. To educate the directors on the code of conduct of directors of listed companies
Initial Public Offering Process
The I.P.O process involves a variety of technical sub-processes that make it possible for a company’s shares to be offered to the public through a primary market and later on “listed” on the Stock Exchange.
IPO processes are governed and regulated by different laws and authorities in different countries. the main processes of IPO in the world include Planning, Implementation, and Closing
In Tanzania IPO processes are governed by The Companies Act, the Capital Markets and Securities & Regulations, Capital Markets and Securities Authority (CMSA), Dar es Salaam Stock Exchange (DSE), etc.
In the USA IPO processes are governed and regulated by the Securities Act and the United States Securities and Exchange Commission
Planning is the foundation of a successful IPO. It is the first step in the IPO process here is where everything is laid down. The following are the main activities involved in the planning stage.
Passing of all necessary corporate resolutions including the resolution to convert the company from a private to a public company
Finding IPO actors and building an IPO team. The IPO team must include an underwriter, lawyer, Certified Accountant, and other actors as seen above.
Preparing all necessary documents including Prospectus or offering documents, various agreements between issuer and actors together with other required formal statements.
conducting Due Diligence. This is an activity that requires attention and intensive work. Here every actor must do everything to make sure that the company is ready for IPO.
For example, the lawyer must examine all the legal issues of the company.
These include the company’s existence as a legal person, its corporate structure, its business, the legal framework in which it operates, properties (both movable and immovable), patents, trademarks, major contractual relations, labor, and matters relating to the environment.
On the other hand, the underwriter and issuer must conduct a thorough valuation to determine the share price.
NB. The underwriter is an investment bank duly registered with relevant authorities, this bank works together with the issuer to determine the Initial share price and it buys the shares and sells them to potential investors.
For example, if the issuer offers 2,000 worth $20 per share.
The underwriter once agreed, may buy those shares for 18 and sell them to the public for $20.
This is the second crucial stage. It is where the real IPO happens.
This is where things are moved from the background to the foreground.
The main activities here are; getting approval from relevant authorities, the underwriter and issuer agreeing on the opening and closing date of the IPO, the number of shares to be offered, and the initial price of the shares.
The initial share price is usually determined by looking at the goals of the issuing company, reputation, and economic status at the time of issuing.
Once everything is done the IPO is live. It is generally advertised in all media to attract more investors.
During this time the emphasis is on the deadline.
However, it is possible to extend the IPO period.
Closing of an initial public offering means the date on which the sale and purchase of the shares of Common Stock sold in the Public Offering is elapsed.
It is followed by a transition to the market competition period.
This period starts 25 days after IPO. Here everything is off the underwriter’s hands and analysis is based on the public views and market competition.
The underwriter may conduct post-IPO valuation and deliver it to the company Also underwriter becomes the advisor when the share price swings.
Initial Public Offering Advantages
The following are the advantages of an IPO
Raise Capital and allow expansion
Raising capital is the main advantage of IPO. By going public, a company can get new investors who are willing to invest their money into the company.
The money invested enhances the expansion of a company.
Through IPO a company may raise enough money to increase its share capital, pay off debt, expand its infrastructure, etc.
Listed on the Stock exchange
Listed on the Stock exchange is prestige.
After going public, a company may be listed on the stock exchange thing which allows the company to trade its share in the stock market and attracts new investors regularly.
This increase the company’s ability to raise a large amount of money from the marketplace
Initial Public Offering Shortcomings
The following are the disadvantage of an IPO
One of the highly complex legal processes is IP.
It involves a lot of technical issues and formalities like research and due diligence, registration, preparation of all required documents, licensing and approval, etc.
The IPO team must comply with everything to validate the deal. Otherwise, they can’t make it.
IPO is risky. Sometimes a company may not reach the targeted amount of money to be raised. This may happen due to several factors including the issuer’s bad reputation and questionable goodwill, economic depression, and force majure.
IPO may cause a lot of distraction to the key leader in issuing the company in a management role.
They may highly focus on IPO instead of management. This distraction may hurt profit.
IPO processes take a long time to complete. It requires a lot of pulling and pushing to make things happen. Most of the issues in IPO are technical and take time to complete.
It needs a lot of money and resources to go public. Money to hire professionals, money to pay required fees, money for IPO marketing and ‘IPO roadshow’
Loss of privacy
IPO requires an issuer to disclose some of the financial and business information to the public. The dissemination of this information may be useful to your supplier, customers, and competitors.
Initial public offering versus secondary offering
A major difference between IPO and a secondary offering is that IPO is when the company is offering its share to the public for the very first time while any other offering which will ‘follow on’ after the IPO is called a secondary offering or follow-on offering or follow-on public offers (FPOs).
In this article, I have endeavored to explain every basic element of an Initial Public Offering.
The bottom line is;
- IPO entails the legal processes through which a private company becomes a public company by offering its shares to the public.
- The main purpose of an IPO is to raise capital.
- IPO works as a legal means to validate the company to operate as a public company.
- That the primary role of lawyers in IPO is to ensure that the process is done strictly within the law.
- The processes of IPO are passing through the planning, implementation, and closing stages.
- Advantages of IPO include. It raises capital and it enables a company to be listed on the stock exchange.
- Disadvantages of IPO include risk, time-consuming, cost, loss of privacy, and complexity.