Once you have read the Glossary of IPO terms, it is then important to understand the IPO process as part of your introduction to investing in IPO's.

1. IPO Basics

An IPO is the abbreviation for an Initial Public Offering. It is the process where a company sells shares to public investors for the first time.

The company will ask an "underwriter" to help it in getting its stock sold to the public. The underwriter is usually an investment banking company who may in turn engages the services of other investment banking companies and brokers. The underwriters charge a fee for their services.

The underwriter will conduct a due diligence of the company by initially investigating the company's financial statements and the management team. The underwriter will then assemble a team including a public relations firm, a law firm (to prepare the necessary filings) and auditor (to ensure the company's books conform to accounting standards).

2. The S-1 Registration Statement and Preliminary Prospectus

The company and the underwriting will then work towards getting a preliminary prospectus and S-1 Registration Statement prepared and ultimately filed with the SEC.

The Registration Statement must contain the following information:

A description of the company's business.
The names and addresses of the key company officers, with salary and a 5 year business history on each.
The amount of stock that each of the key officers own.
The company's capitalization and description of how the proceeds from the offering will be used.
Any legal proceedings that the company is involved in.
A description of a company's target market, competitors, and growth strategy.
 
Once the Registration Statement and preliminary prospectus is filed, the SEC imposes a "quiet period" which generally lasts until 25 days after a stock starts trading. During this quiet period, the company is prevented from sending any materials other than the preliminary prospectus. In essence the company is prevented from promoting the issue and must allow the prospectus do most of the talking and selling for the issue.

3. Next Steps

The underwriter will then gauge investor demand for an IPO so as to determine its offering price. This is referred to as gathering "indications of interest." No commitment of prospectus buyers is required since all sales are prohibited until the security has cleared registration.

Once the Registration Statement has been cleared by the SEC (and by relevant state securities organizations) the company will prepare and file the final prospectus which contains all of the information in the preliminary prospectus including the final price of the issue.

The SEC's clearing of a security for distribution does not mean that the SEC approves of the issue. It merely means that the SEC and relevant state securities organizations have reviewed the Registration Statement and prospectus for any omissions or problems and confirmed that all necessary information has been filed. The SEC cannot confirm whether the information contained in the filing is accurate.

It usually takes about 8 weeks from the time the Registration Statement is filed with the SEC and the time the IPO starts trading.

4. Syndicate and Allocation

In the interim, the underwriter puts together syndicate of investment bankers who together participate in distributing the IPO. A syndicate is necessary since an IPO is usually too large for one underwriter to handle. The syndicate will either make a firm commitment to the issuing company to distribute the entire offering (where the entire offering is not distributed, the syndicate must buy the unissued portion) or make a " best efforts" commitment where the syndicate will not be liable for the unsold portion.

The Underwriters will offer to allocate the IPO to their preferred clients, i.e., clients who have historically generate large commission and trade volume.

5. Making Money and Trading

The underwriter makes money from the spread between the price at which the underwriter buys the stock from the issuing company and the price at which the shares are offered to the public.

On the night before the IPO, a final price will be set. This means that the IPO is then effective and the underwriter will pay the issuing company the amount the underwriters raised less their commission. The underwriter will then sell the IPO at a higher price on the next day, thus generating a profit. The price that the IPO initially trades at is called the "offering price."

After the stock starts trading publicly, the underwriter is permitted under restricted circumstances to stabilize the price of the stock. There can be fine line between stabilizing a stock price and manipulating such price.

Note that directors and other company insiders are usually restricted by the Underwriter from selling their shares for a period of 180 days following the initial IPO trading. This is called the "lock-up period".

You can retrieve a copy of any prospectus by obtaining it online using our Edgar Online SEC filing tool or through our IPO Centre section.

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