Business Law Series, Vol. 2: "Going Public"
By Rick Connors
After starting and maintaining a successful business, it can be difficult knowing the next step. You want it to grow and thrive, but the best way to accomplish this is not always clear. For many, one of the biggest milestones and signs of a growing company, is taking that company public.
Taking your company public means your company is making its Initial Public Offering, or IPO. This simply means it is selling new or existing securities and offering them to the public for the first time. Before an IPO, a company is considered private, so it has a much smaller number of shareholders. After an IPO, the issuing company becomes a publicly listed company on a recognized stock exchange. It becomes publicly traded and owned.
Taking this step has obvious advantages. Most clear among these is the ability to raise capital which could be used to settle old debts and hopefully expand. Meanwhile, the added publicity can help generate new awareness among customers. It lets the world know that you are here and ready to do business.
However, taking your company public can expose it to greater levels of scrutiny. New investors mean new people to report to. You will also have added financial reporting responsibilities under the Securities Exchange Act of 1934. And you will need to keep abreast of other rules and regulations monitored by the Securities and Exchange Commission (SEC). These new expectations can be daunting for smaller companies that have just gone public, and the costs of compliance can be high.
These are just the long-term impacts of having a publicly traded company. There are still many considerations a company must make in order to go public in the first place.
First, a company must select an investment bank to act as underwriter. “Underwriting” is where an underwriter acts as the broker between the company and the public in the selling of the company’s initial set of shares. The underwriter will work with the company to determine the initial offering p
rice and will then buy the securities and sell them through its distribution network.
Choosing a bank to perform underwriting services is not a simple matter. A company should consider the bank’s reputation, expertise, and distribution (who the investment bank can provide the issued securities to.) Under circumstances where an underwriter wishes to diversify its risk, multiple underwriters can be used with one acting as a manager.
There are also different types of underwriting agreements to consider. Under a Firm Commitment, the underwriter purchases and resells the whole offer, guaranteeing the company that a particular sum will be raised in the process. Meanwhile, in a Best Efforts Agreement, the underwriter will not guarantee the amount it will raise. In an All or Nothing Agreement, the offering is cancelled if the underwriter cannot sell every share.
An underwriter must draft certain documents for the agreement to go underway:
The underwriter must draft an Engagement Letter, which typically includes a Reimbursement Clause and a Gross Spread. A Reimbursement Clause mandates that the issuing company covers all out-of-the-pocket expenses incurred by the underwriter. Gross Spread is the difference between the price the underwriter purchased the issue at, and the price at which it then sells the issue. This is typically paid to the underwriter as a fee.
A Letter of Intent will present the intentions of both parties. The underwriter expresses its intent to enter the underwriting agreement, while the company agrees to provide all relevant information and cooperate with the underwriter’s due diligence efforts.
An Underwriting Agreement replaces the Letter of Intent after the pricing of securities. This agreement ensures that the underwriter is bound to purchase the issue at the agreed-upon price.
The SEC requires a Registration Statement is filed after the company and underwriter have agreed on all the details. The Statement includes things such as information regarding the IPO, financial statements, the background of the management, insider holdings, any legal problems faced by the company, and the ticker symbol to be used by the company. The Statement will include a Prospectus, which is provided to investors, and private filings to be issued to the SEC.
The underwriter will also draft a Red Herring Prospectus, which contains much of the same information as the Prospectus, sans details like the effective date, offer price, and number of shares. It effectively expresses that the security offering has been filed but is not yet effective. This Red Herring is filed with the SEC who review it for its accuracy. It can then be used to help market the IPO to potential investors while the Registration Statement and final Prospectus are still under review.
The Big Day
On the day before the IPO’s effective date, the company and underwriter will agree on an offer price and number of shares to be sold. They will consider factors such as market conditions, apparent interest, and the company’s overall goals. Often times, IPOs will be underpriced in order to increase demand.
After bringing the issue to the market, the underwriter has a short period of time in which it offers recommendations and may engage in market stabilizing practices, such as purchasing shares at or below the market price. Then, 25 days after the initial offering, the company enters market competition and investors must rely on market forces to determine the state of their shares.
The IPO is considered successful if its market capitalization (stock price multiplied by total number of outstanding shares) is equal to that of its competitors within 30 days of the initial offering. It is also considered successful if the difference between the offering price and market capitalization after 30 days is less than 20%.
 https://www.investopedia.com/ask/answers/what-does-going-public-mean/  https://www.investopedia.com/ask/answers/advantages-disadvantages-company-going-public/  Id.  https://corporatefinanceinstitute.com/resources/knowledge/finance/ipo-process/ https://www.investopedia.com/terms/u/underwriter.asp#:~:text=IPO%20underwriters%20are%20financial%20specialists,via%20the%20underwriter%27s%20distribution%20network.  Supra note 4.  Id.  Id.  Id.  Id.  Id.  https://www.investopedia.com/terms/r/redherring.asp  Supra, note 4.  Id.  Id.