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Understanding IPOs

Selling a Small Business

Understanding IPOs

Written by Angela Ly for Gaebler Ventures

An IPO is one of the most common methods of exit for entrepreneurs and venture capitalists. We talk about what's involved in the IPO process.

All entrepreneurs should have thought of an exit strategy from the onset of the business.

Most hope that the business takes off and goes public via an initial public offering (or IPO).

The public market is a good way of raising capital for the company and at this point, the entrepreneur feels that the business has really "made it." If you do decide to get your company publicly listed, you should understand the procedures and processes involved.

1. Look for the professionals

After you decide to list, you should start looking for a reliable investment bank to be your adviser. The adviser will provide professional advice and guidance on the entire process, and should be approved by the relevant exchange in the country of listing. The adviser would register the company for the IPO with the exchange.

You would also engage the services of a law firm, which would provide advice on many legal aspects of the IPO.

If the company has an existing auditor, they would usually be the ones who would prepare the prospectus. The prospectus contains financial information about the company and its offering, and would eventually be given to potential investors.

2. Create demand for your shares

The competency of your advisor is critical at this stage. As the value of your company increases with the demand for its shares, the investment bank (your advisor) would create demand for your company's shares. It usually does this by putting your company in relation with comparable companies to obtain a price-earnings ratio, or it could also focus on the growth potential of the company.

Once the investment bank has an idea of the level of interest from investors, it will determine the valuation of the shares. The investment bank typically underwrites the offering. This means that the bank will buy the shares when the offering is in effect, so that the trading price will rise steadily. The bank often applies a discount to the valuation of the shares in order to attract investors.

3. Apportion the offering

The number of shares in the offering is typically apportioned. At least a third is reserved for institutions that are known to trade actively in the IPO market. This is so that the trading pattern of at least this portion of shares can be better predicted. The remaining shares are then allocated to other investors, who comprise of institutions as well as private buyers.

You definitely hope that the demand for your shares are high, made possible by your investment bank's efforts in step 2. While the size of shares requested by buyers can be reduced, the bank can sometimes sell more shares than the offering was originally intended to. The bank is able to achieve this if it had been the first to buy some of your shares, in order to push up the share price when the trading commenced.

4. Everyone gets paid

You, as the share issuer, get the proceeds from the funds paid by buyers of your shares. The investment bank usually handles this through the exchange. It will need to use part of the proceeds to pay the investment bank, the law firm, the auditor and other professional services. The investment bank typically gets 5% to 10% of the IPO price. Your company receives the remainder of the proceeds.

Angela is currently an MBA student at Nanyang Technological University in Singapore. Ms. Ly is looking to specialise in Finance, and has an interest in exploring topics in entrepreneurship and strategies for small businesses.