What do cans of Red Bull, specially designed cakes, and lengthy PowerPoint presentations have in common?
They all form part of the ingredients that can make for a successful initial public offering.
An initial public offering, or IPO, is what happens when a company wants to go from privately-owned to publicly traded. It means selling stock to the public market for the first time.
Alan Li, a former tech, media, and telecom investment banking analyst at Goldman Sachs, broke down the IPO process on a recent episode of his new podcast, “The Vampire Squid.”
Why go public?
Companies choose to go public when they need more capital, Li explained. Private companies aren’t subject to the rules, regulations and policies that public companies are subjected to by the SEC, so an IPO can also show the company’s legitimacy in the market.
An IPO is usually a big marketing event with a lot of news and publicity, generating more hype and customers for the company. Finally, an IPO provides return on money invested early on by venture capital or angel investors.
The bake off
Taking a company through an IPO can be a lengthy process, and that’s where the investment bankers come in. Once a company decides to IPO, they hold a “bake off,” as Li said, or a competition between investment banks to take them through the process. During this “bake off,” banks pitch the company to show who knows them best — who really understands the company, its mission, goals, revenue, and risk factors. Banks usually have a 40-50 page presentation detailing their attributes and why they are in the best position to take the company public.
In addition to the PowerPoint presentation, many banks try different ways to stand out among their peers. Li has seen banks bring an “IPO survival kit” — bags of goodies like Red Bull, pillows, and sleeping bags, a sort of gag gift to show that they’re in it for the long haul.
Other banks have literally baked cakes, decorating them with the company’s logo. Others might show up to the meeting in matching shirts bearing the company name.
The company’s management team and board then pick a winner, which becomes the “lead left” bank on the IPO. This gives them control of the process, bigger percentage of pay, and bragging rights. To “win lead left,” Li said, is a “badge of honour.”
The hard work
This is just the beginning. The next step is for the company to file an S-1 document with the Securities and Exchange Commission, which includes a business description, the legal and business risks of the company, what they will use the money raised in the IPO for, financials, and management commentary, Li said. He said this process can take months, with up to 12 iterations before the SEC is satisfied.
Next is the roadshow presentation, where the lead left bank creates a roughly 30-page presentation on the company for institutional investors, like large pension funds, hedge funds, or mutual funds. These investors get to purchase the stock before the company goes public, and selling to them first brings stability to the stock price.
Roadshow presentation take seven to 10 days, and include face-to-face meetings between investors and company management. These institutional investors give an indication of how many shares they want and at what price, while the bankers take notes in what is called “building the book.” After the roadshow, bankers work out how to allocate these shares, explained Lin, aiming for a mix of stability and liquidity.
Next, the bankers price the shares and sell them to institutional investors the day before the company starts trading. Public investors will see a different, usually higher, price on the day of trading, depending on demand and interest from public investors. When the share price opens higher, it’s the called the “IPO pop.” If the stock price closes that day above the IPO offering price, this is seen as a successful IPO. If the price drops, it’s a botched or unsuccessful IPO. The investment bank running the process may not have priced the company efficiently in the market.
Li takes a more long-term view, however. Facebook is considered one of the most infamous “botched IPOs.” Shares were sold to institutional investors at $38, the stock price was opened to the public at $42, and it traded back to $38 the same day. Twitter was seen as a successful IPO. On the first day of trading, it popped over 100%. Facebook is now worth over $100 per share while Twitter is going downhill.
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