TheStockAdvisor Advice

The Basics About IPO's

What is an IPO?
An IPO, Initial Public Offering, is the initial selling of stock to the public. After these shares are initially issued in the Primary Market at the Offering Price, they are traded in the Secondary Market. The Primary Market consists of Underwriters allocating shares to institutional investors and favored individual investors. The Primary Market essentially represents everything that occurs before the company's stock is traded on one of the stock markets (NASDAQ, AMEX, NYSE, OTC). An IPO, Initial Public Offering, is the initial selling of stock to the public. After these shares are initially issued in the Primary Market at the Offering Price, they are traded in the Secondary Market. The Primary Market consists of Underwriters allocating shares to institutional investors and favored individual investors. The Primary Market essentially represents everything that occurs before the company's stock is traded on one of the stock markets (NASDAQ, AMEX, NYSE, OTC).

Why Does a Company Go Public?
A company goes public to raise money. Going public also makes it easier to raise more money in the future (by issuing additional shares). Other reasons for making an IPO would be to improve a company's profile and increase the potential for mergers or acquisitions.

How the Company Uses the Proceeds?
A company should have a very clear idea of exactly what they are going to do with the capital raised from their IPO. Murky allocation plans can indicate that a company has poor investment prospects.

How to Participate in an IPO (Purchase Shares at the Offering Price)?
It is very rare that the individual investor has the financial clout to participate in an IPO; however, with the advent of online brokerage, it is becoming somewhat easier for the individual investor to participate. Examples of online brokers which are moving into the business of offering IPO shares to average investors are: Charles Schwab, Fidelity, DLJ Direct, E*Trade, and Wit Capital.

Each has its own investor requirements, but these tend not to be as strict as those of Full Service Brokers.

For Full Service Brokers, high-net worth accounts tend to get the most chances to buy IPO stock. Big underwriters like Lehman Brothers, Merrill Lynch, Morgan Stanley Dean Witter, and Salomon Smith Barney accept individual accounts, but only for very large accounts.

Either an Online Broker or Full Service Broker must be part of the Syndicate in order to have the ability to offer shares of any particular IPO. In either case, the likelihood of an individual investor obtaining shares of an IPO is still, at this time, unlikely.

A thorough reading of the IPO terms will give a better understanding of the IPO Market.

Initial Public Offering Terms
Aftermarket Performance - A term typically referring to the difference between a stock's Offering Price and its current market price.

American Depositary Receipts (ADRs) - ADRs are offered by non-U.S. companies who want to list on an American exchange. Rather than constituting an actual share, per se, ADRs represent a certain number of a company's regular shares.

Best Efforts - This term is used to describe a deal in which underwriters only agree to "do their best" in selling shares to the public. An IPO is more commonly done on a Bought or Firm Commitment basis in which the Underwriters are obligated to sell the allotted shares.

Blank Check - A company which indicates no specific industry, business or venture when its securities are publicly offered for sale and the proceeds of the offering are not specifically allocated. Not usually a very good sign.

Due Diligence - A reasonable investigation conducted by the parties involved in preparing a disclosure document to form a basis for believing that the statements contained therein are true and that no material facts are omitted.

Flipping - This is when an investor has acquired an IPO at its Offering Price and sells it immediately for a quick gain soon after it starts trading on the open market. A practice discouraged by underwriters, that can lead such investors to unfavorable relationships with their underwriters with future IPOs.

Lead Underwriter/Manager - The investment bank controlling the IPO process. Two of the most important duties are setting the Offering Price and the allocation of shares to the Syndicate.

Lock-up Period - A "lock-up" is enforced on certain shares after an IPO. The lead underwriter bars a company's directors and executives from selling any of their shares. This period usually extends six months after the IPO date. This practice has also been instituted by online brokerage firms in an effort to quell the volatility of Internet IPO stocks.

Market Capitalization - The total amount of a company's shares outstanding multiplied by the price per share. Due to popularity with investors, Internet stocks often have "market caps" which are somewhat out of line with their earnings and revenues.

Offering Price - This is the price set by the Lead Underwriter (also known as Lead Manager or Lead Book-Runner) at which the company's stock is sold to the first round of investors.

Offering Range - This is the price range which the company expects to sell its stock. This can be found on the front page of the Prospectus and by no means must be adhered to. As with everything traded, market conditions and demand dictate the final Offering Price.

Opening Price - This is the fist price that the company's stock trades on its first day of trading.

Over-the-Counter Market (OTC) - A market made up of dealers who make a market for those securities not listed on an exchange. The over-the-counter market is made between buyers and sellers over the telephone, rather than the auction-type market found on exchanges.

Pink Sheets - Used in the over-the-counter market printed daily listing the market-makers and the current quotes on stocks.

Pricing Date - This date usually refers to the night before shares are sold to the general public. Companies and their Underwriters customarily set an IPO's price after the markets have closed in anticipation the commencement of trading in the morning.

Primary Market - Where shares are distributed at the Offering Price to investors.

Private Placement - An offering of a limited amount of shares or units, in which the recipients receive restricted stock from the issuer.

Prospectus - This document is an integral part of a company's S-1 form, which must be filed with the Securities and Exchange Commission. It defines, among many things, the company's type of business, use of proceeds, competitive landscape, financial information, risk factors, strategy for future growth, and lists its directors and executive officers.

Quiet Period - This period starts once a company has filed its S-1 or SB-2 form with the SEC and extends 25 days after the company's stock has started trading on the open market. During this time the company and Syndicate are prohibited from making any statements which are not included in the Prospectus. That is, the company may not say or do anything which might affect the IPO or the stock's performance in the Aftermarket.

S-1 - This a type of form filed with the Securities and Exchange Commission. It announces a company's intent to go public. The Prospectus section is an integral part of this filing.

Secondary Market - Better known as the Stock Market, where shares are openly traded.

Supporting Companies - These are the companies which help the underlying company go public. This group is comprised of the auditors, the attorneys, and the transfer agent. There are currently five auditing firms which control an estimated 90% of the IPO Market: Arthur Andersen, Deloitte & Touche, Ernst & Young, KPMG, and PricewaterhouseCoopers.

Syndicate - This term is used to refer to the group made up of the Underwriters and other Supporting Companies.

Transfer Agent - This agency handles the transfer of shares from one person to another. It records the names and addresses of a company's stockholders, as well as the share amounts they own.

Withdrawn/Postponed - From time to time a company will decide that market conditions are out of favor and not conducive to a successful IPO. There are many reasons why a company will decide to Withdraw its IPO. Among these reasons are: a simple lack of willing investors at at that time, market volatility, or the emergence of a bear market. When a company withdraws its filings with the SEC, the IPO is usually delayed for at least six months.

(We at TheStockAdvisor would like to thank our friends at IPO.COM for providing this information.)


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