Risks during the IPO Process

Seminar Paper, 2016

17 Pages, Grade: 1,7



List of tables, figures, and acronyms

1. Introduction
1.1 Statement of the problem
1.2 Approach and goal of this paper

2. Initial Public Offering
2.1 Reasons for IPOs
2.2 Process of the IPO

3. Risks of IPOs
3.1 Costs
3.2 Underpricing
3.3 Reduction in amount of share
3.4 Unfriendly takeover

4. IPOs of Facebook and Twitter
4.1 Facebook
4.2 Twitter
4.3 Conclusion

5. Critical appraisal
5.1 Development of international IPO market
5.2 Alternatives to IPOs

6. Conclusion


List of tables, figures, and acronyms


Abbildung in dieser Leseprobe nicht enthalten


Table 2.1: The IPO Phases


Figure 5.1: Global IPO and M&A by deal numbers

1. Introduction

Companies all over the world need liquid assets to start, grow or save their businesses. There are several options for companies to get access to these assets, such as the classical use of revenues or to raise a credit at a bank. But these options are maybe not sufficient enough or limited in time. To reach their goals companies can raise the funds in the capital market through an initial public offering. Due to the advancing globalization and digital- ization companies theoretically can gather money through the IPO from all over the world. As the IPO is considered to be one of the most significant events in the life cycle of companies a profound analysis of the advantages and disadvantages of IPOs is needed to be conducted by the companies.

1.1 Statement of the problem

What are the risks during the IPO process? Companies have to take into account all pos- sible risks during the IPO process and the risks after the actual IPO, before deciding to perform an IPO. The risks can have only minor impact on the company in some cases or major impacts which could lead in the worst case scenario to the bankruptcy of the com- pany. Therefore the decision has to be balanced thoroughly by the companies.

1.2 Approach and goal of this paper

The chapters 2 and 3 will focus on the theoretical literature of the IPO definition, reasons for IPOs, and the risks of IPOs in detail. In the subsequent chapters 4 and 5, the practical aspects of the IPO will be discussed. Chapter 6 will summarize this seminar paper with a conclusion. In the whole process of the IPO are many stakeholders involved with different perspectives and purposes. Therefore this paper will bring the view of the company into focus. As the IPO process is complex and differs from country to country the following elaborations are kept international with no details on individual country requirements. The goal of this paper is to describe the reasons for IPOs and the risks, to provide an overview of the IPO process as a whole. With practical examples and studies, the theory will be made clearer.

2. Initial Public Offering

The Initial Public Offering (IPO) is a process, where private companies sell their stocks to the general public on the primary market for the first time (Lubig, 2004, pp. 6-7.). The primary market differs from the secondary market, where only already existing stocks are being traded (Geddes, 2003, p. 7). In Anglo-Saxon literature ‘going public’ is often used as a synonym for IPOs (Lubig, 2004, p. 7). A public listing fundamentally changes the company’s legal and economic structure. The management is now responsible for a new group of shareholders, unlike the concentrated ownership of a private company. Infor- mation regarding the company’s financial situation and operations that had been kept pri- vate in the past must now be publicized. In this chapter, the reasons why companies decide to go public, will be listed and explained in detail. Also, the entire process of the IPO will be expounded.

2.1 Reasons for IPOs

‘Why am I going public?’ This is the question which companies and their CEOs have to ask themselves before the IPO. The reasons for IPOs are various and can be separated in financially and non-financially motivated benefits. According to theoretical literature, the major financial benefits are as follows. By creating and selling stocks to the public, com- panies will raise capital as equity. The capital will be mainly used for strengthening the equity structure (Ek, 2001, p.178) and as a source for growing the company (Draho, 2004, p. 59). This type of financing has two advantages over debt capital, as it does not have to be repaid, nor are there regular payments to be made (Geddes, 2003, p. 8). If the company already has debt capital or considers to raise additional debt capital the high amount of equity, which has been raised through the IPO, will decline debt financing costs (Perridon, 1993, p. 423.). A further financial benefit for an IPO is the increase in the set of financing options available to a company. Various equity-linked securities are an opportunity now that the company trades shares publicly. Convertible debt and warrants are two examples. As the investors have better information about the company further debt and derivative products become practical (Draho, 2004, p. 60). Besides the above mentioned financial benefits the following non-financial benefits play a role in the decision for going public. Due to the IPO, the company recognizes coverage in the media which leads to a higher level of awareness and enhanced standing towards customers, suppliers, banks, and other cooperation partners. For example, the higher reputation can lead to an increased turnover of products and services of the company or cheaper purchasing conditions provided by suppliers. Also from a marketing perspective, the higher brand awareness can be benefi- cial (Schanz, 2012, p. 10). Furthermore, for existing and prospective employees the higher level of awareness is significant, too. For high profiled employees the status of being public shows that the markets regulate a company in a way that achievements are likely to be rewarded. Employees often receive incentive contracts which provide stocks as bo- nus payments (Ghadri, 2012, p. 60). Although all these mentioned benefits seem to be attractive for companies, there are also risks of an IPO which have to be considered and traded off by companies before going public. The risks will be described in chapter three.

2.2 Process of the IPO

The following table shows the major steps of the IPO process which have to be conducted for a successful realization of the IPO.

illustration not visible in this excerpt

Source: Own compilation based on Geddes (2003), p. 55 and Ghadri, (2012), p. 47 Table 2.1: The IPO Phases

The beginning of the process (Pre-IPO Phase) starts in Phase 1 where companies make the fundamental decision to go public. They should start the preparation as much as two years in advance of the IPO. For a successful realization of an IPO, several criteria have to be taken into account and a detailed financial planning is essential (Ghosh, 2006, p. 21). Also, the companies have to ask themselves if they are ready to go public. The fol- lowing components are the most important for assessment: Capability of Management, financial track record, industry prospects and growth potential, position within the indus- try and valuation/comparative value (Geddes, 2003, p. 45). With this information and aligned with the general strategy the company has to create the equity story which is the most crucial signal that persists throughout the whole process and which has to be con- sidered carefully in the Pre-IPO Phase (Ghadri, 2012, p. 46). In Phase 2, which takes place 6 to 5 months prior the IPO, will be the establishment of the legal and organizational requirements. This means in particular that companies will demand legal counsel which will support during the IPO process regarding all legal aspects. A crucial task in this phase is the choice of the underwriter that is generally an investment bank or a consortium of several banks. The investment bank provides up to three services, such as advisory which includes administrative preparation of the prospectus and advice on setting the offering terms, underwriting of the offering by committing to bear some or all of the risk of the IPO and the third service is the distribution of the shares to the investors (Draho, 2004, p. 187). Together with the bank, it is customary to conduct a due diligence. Due diligence is the process where information about the company is gathered in order to produce a document that provides a full disclosure which mitigates liabilities for those potentially at risk (Geddes, 2003, p. 108). Phases 3 and 4 are called the Emission Concept IPO Phase. In phase 3 (4 - 2 Months prior the IPO) will be the creation of the prospectus which is the central element of the IPO process. It is a document that basically serves as a brochure for the company and contains all financial information which needs to be clarified for potential investors and analysts. All information stated in the prospectus have to be cor- rect otherwise, the company and the responsible managers will be made legally account- able (Ghadri, 2012, pp. 69-70). Also in Phase 3 the company valuation will take place. There are several types of valuation, such as multipliers, discounted cash flow valuation or the Capital Asset Pricing Model. After the valuation the company will set a price range to give investors an idea of what value they consider reasonable. Shortly before Phase 4 the research will be conducted which includes pilot fishing, the preparation of analysts’ presentations, invitation of analysts and the announcement of the IPO (Ghadri, 2012, p. 49). The publication of the research leads to Phase 4, the marketing and implementation of the IPO. This phase takes place about 8 - 1 week(s) before the actual IPO. Beginning with the publication of the prospectus and the roadshow where the company and the in- vestment bank presents its case for the IPO to mainly institutional investors. The company needs to impress the investors so that they are willing to buy a significant stake of the company (Ghosh, 2006, p. 24). During the roadshow, the book building process starts to cover the investors’ price expectations. At the beginning a fundamental price for the com- pany is evaluated by the investment bank and the investors will be approached to conduct price assessments by themselves. These assessments will then be incorporated into a price span which deviates by around 10-20 % and the investors are able to make offers within this price range. The investment bank collects supplied orders in the so-called book run- ner. The final emission price will be detected by applying supply and demand after the book building has been completed and the stock volumes will be allocated at this price and listed on the stock market (Ghadri, 2012, p. 90). For stabilization of the share price, the investment bank can purchase up to 15 % of the total offering from the company. During the first 30 days of trading, the investment bank has the option to stabilize the share price by facilitating the distribution of shares (Geddes, 2003, pp. 205 - 206). In Phase 5, the Post-IPO Phase, the investor relations activity starts and secondary market assistance by banks will be provided.

3. Risks of IPOs

In the following chapter, the risks and disadvantages of IPOs will be explained. Chapters 3.1 and 3.2 describe the risks during the process and chapters 3.3 and 3.4 the risks which could occur after the IPO.

3.1 Costs

The costs of an IPO can be separated in preparation costs and running costs for being public. Generally, the preparation of the IPO takes up a lot of time of the management team and employees (Ghadri, 2012, p. 62). As preparation costs can be counted the change to the correct legal form for the company, if needed. Depending on the country and legal form the costs may vary here (Reschke, 2007, p. 16).


Excerpt out of 17 pages


Risks during the IPO Process
University of Applied Sciences Essen
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IPO, IPO Process, Underpricing, Overpricing, going public, Börsengang, Seminararbeit, FOM, Initial Public Offering, Twitter, Facebook, finance, international finance, investment, winners curse
Quote paper
Tim Meierkord (Author), 2016, Risks during the IPO Process, Munich, GRIN Verlag, https://www.grin.com/document/349158


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