The initial public offering is the first public offering of shares for any public company. This event is important and i will provide an in-depth explanation, as it will help us set the base line for the other events.
Share history and types
A company can issue shares for the first time without using an IPO, the shares can be issued and distributed to specific persons in what we call Over-The-Counter (OTC), which means in a non public way, the deal is made between the company directors and the the share buyers. The only public entity that knows about this is the Depository clearing which is the main establishment that holds records of ownership for all the securities in any country.
Shares can be issued in different types:
- Registered: Ownership is registered at the company level, here is dummy example:
- Bearer: Ownership is defined by the holder of the share document, the details of how many shares issued are all written in the share document and anyone holding the document is considered the owner. Here is a dummy example:
Initial Public Offering implementation
The company will implement an IPO when it decides to list in the Stock exchange and have its shares traded and listed their.
A process is initiated for this matter and several details needs to be fixed for this operation to take place such as:
- Number of shares to be presented to the public in this IPO:
- Existing shares: existing shares can be sold in the IPO
- New shares: The company can issue new shares to be offered to the public in the IPO. This happens most of the time because the company usually tries to get more funds to support its activities, that why we say “Fund raising”
- Issue price: The price to be paid by anyone who wants to become a shareholder in this company and is defined by a range (Min-max).
- Offer period: The period in which the shares will be available for purchase. The purchase can be conducted by a letter to the company, electronically using brokers platforms or via phone calls.
Here is an example:
As you can see, the company ‘NEOEN’ is having an IPO, while it already has 54 397 070 shares in its existing capital.
So 28 125 00 shares can be issued (why not necessarily ? because the public may not be interested in those shares and won’t buy them).
10 768 642 existing shares will be presented for the public by some hedge funds (FPCI Capenergie….).
Book-runner rule in the Initial Public Offering
Above you can see the price range which is a range that the company responsible for the IPO (what we call a “Book-runner“) will try to keep the price in.
Here is an example of the book-runners, they can also do other tasks as being the “Global coordinators”, “Lead Managers” and “Listing agents”. The IPO process is complicated and multiple financial agencies are brought together to help in the process:
How is this done ? let’s see:
Now we introduce the concept of the “Green-shoe” option: A certain number of shares that can only be issued by the book-runner to operate in the IPO in order to keep the price of the share in the price range explained above.
As you know price varies according to offer/demand (in a free market), if the price in the IPO starts going down towards the lower range due to low interest in the shares, the book-runner will start buying to push the price up, and if the price starts getting above the price range, the book-runner will do the opposite and starts selling the shares to keep them affordable for most of the public.
Over-allotment option: This is another concept you should be aware of which defines the number of shares that can be issued and sold to the public in case there is strong demand on the company’s shares in an IPO
Another idea that must be cleared is components of the issue price. You should be aware that the issue price is composed of two things:
- Par value: This is defined as the minimum value that the share may have at any given moment. Normally the share trades at a much higher value. The sum of all par values of all the shares is registered in the “Share capital” account.
- Issue premium: This is another value added to the issue premium to compose the share price. The sum of all the issue premium values are registered in the “Issue premium” account.
Here is another explanation using graphs:
So the issue price = Par value + Issue premium
I bet you like graphs, here is another global illustration of the process, for the sake of your understanding:
1- Company decides to implement an IPO
2- Company decides which shares to bring to the IPO (New and existing)
3- Company deals with multiple financial agencies to run the IPO
4- Financial agencies sell the company’s shares using Phone calls to existing or new clients, brokers platforms or written requests from clients through mail.
5- The stock exchange then lists all the shares sold in the stock exchange by providing the share an ID which is called “ISIN”, a symbol and a label
If everything goes expected, the IPO is declared as a success and everyone becomes happy and starts applauding:
Why everyone is happy ?
Company: the company has now proven that its strategy and idea is accepted and encouraged by the public and the market in general. It also has compiled a good sum of money that it can use to extend its activity and make more profits.
Book-runner: The book-runner has proven its ability to sell shares to clients and the public and he made a good amount of profit from selling the shares to the public as well as the fixed cost he earned from managing this operation.
Shareholders: The new shareholders are also happy as they now hold shares in a good that company that has good growth prospects which would also mean the share price is probably going higher in the future meaning more profits for them.
I think this is enough for the IPO,now you can checkout the other events that may happen in the life time of the company after it gets listed and traded in the stock exchange.
IPO example source documents can be downloaded here. We have used an IPO for a company to be listed in Euronext market, but the key elements are the same in any market. You can find the English version after the french version just scroll down in the document:
If you have any questions or if you would like to add something please be welcome in the comments.