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IPOs
1
IPO
An IPO is the first time that the general public
is able to invest in the firm
 An IPO generally happens when a firm needs
more money than it can raise from VC’s

 VC’s
come in after credit cards, friends, and
family
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Venture Capital


These are typically limited partnerships, where
investment managers raise money from qualified
investors
Four main suppliers of venture capital:
1.
2.
3.
Old Money
Large firm with established venture-capital subsidiaries.
Qualified Individuals

Individuals worth over $1,000,000 and incomes above
$100,000
The Basic Process



Management gets Board approval to go public
The firm files a registration statement with the
SEC
The SEC studies the registration statement
 This


is the waiting period
The firm prepares and files an amended
registration statement with the SEC
Once the firm gets SEC approval, starts selling and
sets a share price
An Example of a Tombstone
Types of IPO’s
Firm Commitment
 Best Efforts
 Dutch Auction

Firm Commitment


The firm sells the shares to the underwriting
syndicate (Primary Sale)
The Syndicate resells to the public (Secondary
Sale)
 Spread:
difference between what the syndicate buys
the shares for and sells them for
In
the US the spread is typically about 7%
 Syndicate bears the risk of not selling all the
shares
 Most
common type of IPO in the US
Best Effort

Underwriter makes a “best effort” to sell the
securities at an agreed-upon price
The firm bears the risk of not selling all shares
If there is not enough demand the firm can pull
the offer


Firm still pays the underwriter, but keeps all the shares
Not very common
Dutch Auction

The underwriter simply records investors bids
 Number
of shares and price per share
 Greatly reduces the importance of the underwriter
The price is the highest bid that clears the market
 Investors have an incentive to bid high
Higher bids are more likely to win, while you
are unlikely to pay the price you bid
 Google was the first large Dutch Auction IPO

Dutch Auction Example

Firm TUM is offering 1,000 shares through a Dutch
Auction. What is the price of each share?
Investor
Price Bid
Shares
Bid
Abbie
Bill
$75
$70
500
250
Charlie
David
Edward
$65
$60
$55
150
100
75
Fancy
$50
200
Win
Shares
Received
Price Paid
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IPO Underpricing
IPOs are generally offered at a prices below
their true market value
 This implies that the firm is “leaving money
on the table”
 IPOs are potentially underpriced because:

 Of
the difficulty in setting an accurate price
 Private companies are very hard to value
 Underwriter wants to ensure a large day one return
 Managers want to ensure their ability to go back to
the market
SEOs
A Seasoned (Secondary) Equity Offering is
when a public company offers additional
equity to the public
 This is generally the result of the firm needing
cash for investments

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SEO Announcement and Firm Value
The market value of existing equity drops on the
announcement of a SEO
 The price may drop because:

 Managers
are likely to issue stock when they think it
is overpriced
 May be issuing equity to repurchase debt, because of
a fear of financial distress
 A share now entitles you to less of the company than
it did before the SEO
The Costs of Equity Public Offerings
Proceeds
(in millions)
2 - 9.99
10 - 19.99
20 - 39.99
40 - 59.99
60 - 79.99
80 - 99.99
100 - 199.99
200 - 499.99
500 and up
Direct Costs
SEOs
IPOs
2.88%
15.36%
8.81%
11.63%
7.24%
9.81%
6.20%
9.21%
5.81%
8.65%
5.56%
8.34%
5.00%
7.67%
4.26%
6.72%
3.64%
5.15%
Underpricing
IPOs
18.18%
10.02%
17.91%
29.57%
39.20%
45.36%
37.10%
17.72%
12.19%