Initial Public Offering: An Introduction to IPO on Wall St

By Marc René Deschenaux

The IPO - Initial Public Offering - is one of the most complex financial transactions. Understanding the process is not easy, and far too many people, including experts, talk about the IPO without any understanding of other fields outside of their own. This informative guide was written to share real knowledge that debunks myths and fake information, as it provides real knowledge and perspectives from multiple fields and disciplines.

Understanding the IPO requires knowledge in finance, in many national and international laws, in marketing trends analysis, in macro/micro economy, in financial public relations, in econometrics, in fundamental corporate analysis, in financial and securities markets analysis as well as in accounting, whether traditional, financial, or analytical. This book shares need-to-know information that is supported by an understand of all the fields and disciplines. It is the first book of the series that helps readers to apprehend the environment and the context in which the IPO occurs.

• Language: English
• Publisher: BookBaby
• Release date: Sep 3, 2021
• ISBN: 9781736451502

Book preview

A word from his first partner

Marc Deschenaux deserves the praise of his teacher Tom March but as always, the best students go further than their masters. Marc has his own thoughts and actions which follow from his apprenticeship in IPOs.

It is often said to be an expert one needs to invest 10,000 hours before they can claim the title. Marc is an expert in so many things he must be nearly 100 years old. There are few people who have a grasp of how society and the economy work together, and it needs a person with multiple expertise’s to behave within that understanding.

It is commonly agreed that Humanity has reached adulthood meaning we now are responsible for ourselves and our planet. Marc intuitively knows this and understands the engine of society is the economy, but he goes further behaving as the engine is the wrong metaphor as society, the economy and all other aspects of the planet are alive.

In a new way of looking at the economy the institutions and processes are not just in need of renewal they are in need of constant change as are all living things.

Marc describes the current IPO institutions and processes in a way we can understand in the old mode. However, with careful reading he is suggesting a movement into a new mode.

In the economy as it is there are other deep-seated issues among them are the fundaments of dealing with Intellectual property and knowledge of the space as a whole.

If you review his CV, you will note he has actions in both of these areas.

Marc is beginning to show his many areas of expertise and we hope his first book will be a success in showing that IPOs are the way to make sure new knowledge is brought to the benefit of society.

There must surely be further gems from this fertile mind.

Mike Horner

Founder of Company X,

First Partner of Deschenaux & Partners,

Advisor to Marc Deschenaux

1. Definition

Merriam-Webster Dictionary defines IPO as "the first sale of a company's stock to the public¹."

Not a very insightful definition, right?

A more insightful yet simplified definition of an Initial Public Offering (IPO) is "the process of offering shares of a privately owned corporation to the public in a new stock issuance²."

The purpose of an IPO is to raise capital from public investors. The steps involved in the IPO process are discussed later in this book. But, before we dive into the IPO process, it is important to gain clarity regarding its definition and what it entails.

This can be tricky because each of the different online resources on IPO have a slightly different take on it. For example, the definition of IPO given above is a generalized definition of an Initial Public Offering provided by Investopedia.

The economic times provides the same definition of an IPO using different vocabulary. However, it also adds to it by mentioning that a private company wanting to go public through an IPO could be "a new, young, company or an old company which decides to be listed on an exchange and hence goes public³."

The Free Dictionary, an online dictionary and encyclopedia that consolidates information from various sources to define different terms, provides a more detailed insight into an IPO with the following definition:

"The first price for which a company offers to sell stock in itself when it moves from private ownership to public trade. More generally, it refers to the actual first sale of stock to the public. Small companies looking for a new source of financing offer most IPOs, but large companies who wish to be publicly traded can offer them as well⁴."

IG, an online trading provider, clarifies what happens after a company issues the actual first sales of stock through an IPO:

After an IPO, share ownership is opened out to the wider market, which is why IPOs are also known as floating, flotation, or ‘going public’. It is further understood that, When a company embarks on an IPO, it lists a certain number of shares on a stock exchange in order to raise investment capital. IPOs are one of many ways in which companies can seek to raise capital, with other popular options including finding major investors, crowdfunding or using retained earnings⁵."

All of the above definitions provide additional insight into the IPO process. The definition by My Accounting Course does the exact same by stating the medium through which companies go public. It does this in the following definition of an IPO:

"Initial public offering (IPO) is the initial sale of a company’s shares to institutional investors, who sell them to the public through a securities exchange⁶."

As mentioned above, all of the above definitions add something to the meaning of an IPO. If I was to combine all of these definitions taking only the unique part from each, the definition of an IPO would read something like this:

The first sale of a new, young, company or an old company’s stock to the public through the process of offering them shares of a privately owned corporation in a new stock issuance. An IPO opens out share ownership to the wider market by allowing companies looking for a new source of financing to list a certain number of shares on a stock exchange in order to raise investment capital. The shares are sold to institutional investors, who sell them to the public through a securities exchange.

This definition of an IPO can be used as a reference point to understand the IPO process detailed in this book. However, the best way to understand an IPO is through a real-life example. This is exactly what is used to get readers started with Initial Public Offering (IPO).

2. Introduction to IPO

Before a company goes public through an IPO, it has a limited number of shareholders and thus the capital available to it is also limited.

No matter how much money you have available to pump into your business through personal investments, strategic partnerships, angel investors, or venture capitalists, it can never match up to what you would have by going public.

When you go public with your company, you expand your pool of potential investors and are ultimately able to raise more capital than before. Let me explain this using a real-life example.

Our childhood is probably is the most interesting period in our lives. Not only is it a time when we have the most fun, but it is also a time when we love to experiment.

While the amount of experimentation someone did during their childhood would vary from person to person, certain experiments were done by all of us. One of them was experimenting with a waterspout.

If you recall your childhood days, playing in the garden with a waterspout would probably be one of the first memories to come to mind. Do you remember what happened when you pressed your thumb against the waterspout? You felt pressure beneath your fingers, right?

And what happened when you let loose? The water splashed out all at once upon release and reached a greater elevation than it would have if you simply opened water and let it flow out.

What do you think made the difference in the first case? It was the pressure applied.

Within a waterspout, water collects at the same place and all of it is released at the same time. If no pressure is applied to the water, it will simply flow out without any particular direction or energy.

The same is applicable to the securities market where offer and demand are fluxes that can be compared to water flows. Both offer and demand fluxes are dealt with by an Initial Public Offering (IPO) within the same instant.

To understand what makes an IPO so valuable, you need to know its alternatives and what they accomplish.

The first alternative to an IPO is a merger. While it is a good way for a private company to increase its stock price, a merger will only go through if the private company adds to the revenue, profit, or valuation of the publicly limited company it is merging with.

On the other hand, a reverse merger—the other alternative to an IPO—is an easy route to becoming a public company but it will rarely, if ever, result in an increased stock price of the company. This is because many of the problems and challenges that caused the public company being bought to become a shell—a company that exists only on paper and has no active offices, employees, bank accounts, assets, or passive investment holdings—will remain. In other words, there will never be enough market making to reach even a fraction of the performance of an IPO. With the above in mind, the best solution for private companies is to go public through an IPO!

2.1 What is an IPO?

An initial public offering (IPO) is how most companies get established as a public corporation. While some businesses are newly formed from scratch through an IPO, most firms transition from an existing business into a corporation through an IPO.

An IPO changes many things about the way that management runs the firm and can present opportunities and dangers for investors. IPOs are more common during bull markets and a booming economy. A rally in the overall stock market provides a fertile environment for these corporate events.

2.2 What is an IPO Valuation?

An initial public offering (IPO) is the method of converting a private-owned business into a public corporation whose shares are exchanged on a stock exchange. This method is often alluded to as going public. The company is owned by the shareholders who buy its stock after it becomes a public enterprise.

Many shareholders who take part in IPOs are unaware of the procedure through which the value of a business is ascertained. An investment bank is employed before the public disbursement of the stock to ascertain the business’s value and its shares prior to their listing on an exchange.

For investors, assessing a corporation with a newly issued stock that was not previously listed on a stock exchange may be intimidating. However, savvy investors may seek to comprehend the financials of a business by analyzing its registration documents and then reviewing its financials to decide if the stock is valued fairly.

Furthermore, it is necessary for anyone serious about being an early investor to study the different aspects of how an investment bank performs an IPO valuation for a business.

2.2.1 The Components of an IPO Valuation

An effective IPO is based on the customers’ interest in the shares of the company. Strong demand would result in higher stock prices for the business.

In addition to the market for the shares of a business, there are many other variables that decide an IPO valuation, such as similar stocks in the market, growth potential, and the company's background.

2.2.2 Demand for Company’s Stock and IPO Valuation

Strong demand for the stock of an enterprise does not inherently mean that the business is worth more. It does, however, imply that the business would have a higher valuation.

An IPO valuation is the mechanism by which an expert establishes the fair value of the stock of a company. Due to market conditions and an IPO’s timing, two similar businesses can have very distinct IPO valuations.

Typically an enterprise can only perform an IPO when they conclude that there is strong demand for their products. Many tech companies had huge IPO valuations at the height of their boom in 2000.

They earned significantly higher valuations in comparison to the businesses that later went public, and as such, they were the beneficiaries of much higher venture capital. This was primarily due to the fact that, in the earlier part of the 2000s, tech stocks were rising and had an extremely high demand; the higher valuation was not simply a result of these companies' dominance.

2.2.3 Industry Comparables

Industry Comparables are another component of IPO valuation method. If the IPO applicant is in a market with similar publicly listed firms, a comparison of the valuation parameters attributed to its rivals will be included in the IPO evaluation.

The reasoning is that investors would be able to pay the same price for a new market entrant as they already do for existing businesses.

2.2.4 Growth Prospects

An IPO valuation is highly dependent on future growth forecasts for the business. The main goal behind an IPO is capital financing to fuel growth ambitions. The successful selling of an IPO is generally dependent on the forecasts for the business, and whether or not they will grow strongly.

2.2.5 A Compelling Corporate Narrative

Not all of the variables constituting an IPO valuation are measurable. The story of a corporation can be as important as the predictions of a company's sales.

A valuation method may determine whether or not a corporation provides a new product or a service that can fundamentally change an industry or be at the forefront of a new business model.

The companies that invented the Internet in the nineties are a perfect example of this. Since they were pushing innovative and revolutionary innovations, some of them achieved multibillion dollar valuations. This was inspite of the fact that they didn't generate any income at the time.

Through recruiting experienced professionals and advisors to their workforce, some businesses will fabricate their corporate image by attempting to create the impression of being a company with seasoned management.

Often a company's actual results can be distorted by its marketing strategy. This makes it crucial for early investors to study a business’s financial and be mindful of the consequences of investing in a firm which has no proven trading history.

2.2.6 Risks of Investing in IPOs

An IPO aims at selling a set number of shares at an acceptable price. As a result, businesses typically only undertake an IPO when they expect that there will be strong demand for their stock.

If the demand for a business’s stock is favorable, it is often probable that the speculation around the offers of the firm will eclipse its reality. This provides a favorable situation for the business to collect money, but not for those looking to invest in its stock shares.

2.2.7 Key Takeaways

In addition to the market for the shares of a business, there are many other variables that decide an IPO valuation, such as similar stocks in the market, growth potential, and the company's background.

Often a company's actual results can be distorted by its marketing strategy. This makes it crucial for early investors to study a business’s financial and be mindful of the consequences of investing in a firm which has no proven trading history.

An aspect of the IPO launch process is that businesses are expected to generate cash flow statements, income statements, and public balance sheets.

One drawback of buying shares in IPOs is that businesses generally don't have a strong tradition of reporting their financials, and they don't have a proven trading history. As such, it can be difficult to predict those using traditional methods.

2.3 The Challenges with IPOs in the Past

A few decades ago, the process of getting listed on the stock exchange was very complicated and time consuming. There were a lot of legal forms, undertakings and declarations that were required from a business looking to get incorporated.

The only enterprises allowed into the club were successful businesses with a record of top performance. The others were government backed or institutionally funded organizations. New entrepreneurs with visionary ideas had to jump through hoops to get registered to raise money.

This turned a lot of budding entrepreneurs and creative businesses away from the stock exchange. New entrepreneurs sought to raise finances through other means, such as bank loans or private equity investment. Going for an IPO was too big of a headache and most new businesses had to try their luck elsewhere.

Even today, many companies raise the starting capital by taking out from their own personal banking accounts or by acquiring loans offered to small businesses. An increasing number of businesses also get initial funding from venture capitalists private investors. Some use all of these sources to raise the desired capital. However, there often comes a point where a business required must more money than it can raise through an established financial