Investor Bulletin: Investing in an IPO - MemoFin.fr

INVESTOR BULLETINInvesting in an IPOThe SEC’s Office of Investor Education and Advocacy isissuing this Investor Bulletin to provide investors withinformation they should consider when investing in theshares of a new public company.What is an IPO?Historically, an initial public offering, or IPO, hasreferred to the first time a company offers its shares ofcapital stock to the general public. Under the federalsecurities laws, a company may not lawfully offer or sellshares unless the transaction has been registered withthe SEC or an exemption applies.To register an offering, a company files a registrationstatement with the SEC, typically using Form S-1.Some offerings may involve other registration statementforms. An important part of this registration statementis the “prospectus” that will be used by the company tosolicit investors. The prospectus is the offering documentdescribing the company, the IPO terms and otherinformation that an investor may use when decidingwhether to invest. It is important to read the prospectusbecause it provides information regarding the termsof the securities being offered as well as disclosureregarding the company’s business, financial condition,management and other matters that are key todeciding whether the offering is a good investment.Registration statements for IPOs are subject to reviewby the SEC’s staff to monitor compliance with applicabledisclosure requirements. In such reviews, the staffconcentrates on disclosures that appear to conflict withSEC rules or the applicable accounting standards andon disclosure that appears to be materially deficient inexplanation or clarity. The staff’s review often results inrevisions to the prospectus. However, the review processis not a guarantee that a company’s disclosure is completeor accurate, and the staff does not evaluate the meritsof any IPO or determine whether an investment isappropriate for any investor. Rather, responsibility forcomplete and accurate disclosure lies with the companyand others involved in the preparation of the company’sregistration statement and prospectus.Once any staff comments have been addressed, the staffwill issue an order declaring the registration statementeffective, which means the company may proceed toconsummate its IPO. Although the staff will notdeclare a registration statement effective if the staffhas reason to believe that the disclosure is incompleteor inaccurate in any material respect, the SEC’sdeclaration of effectiveness does not represent anapproval of the merits of the IPO or an indicationthat the information disclosed is complete or accurate.Investor Assistance (800) 732-0330www.investor.gov

The underwriters of the IPO typically will have obtained“indications of interest” from prospective investors priorto effectiveness and will use this information torecommend a price for the shares to the issuer, whoultimately determines the price of the IPO. Underwritersare the investment banks that manage and sell the IPOfor the company.An IPO helps to establish a trading market for thecompany’s shares. In conjunction with an IPO, acompany usually applies to list its shares on anestablished stock exchange, such as the New York StockExchange or NASDAQ. Any planned exchange listingwill typically be disclosed in the prospectus for theIPO. The new public company will also be required ona going-forward basis to disclose certain information tothe public, including its quarterly and annual financialstatements on Forms 10-Q and 10-K.How do I invest in an IPO?An IPO gives the investing public an opportunity toown and participate in the growth of a formerly privatecompany. By their nature, however, IPOs can be riskyand speculative investments.nThere are two ways the general public can invest ina new public company. First, if you are a client ofan underwriter involved in the IPO, you may beoffered the opportunity to directly participate inthe IPO. In this instance, you will be able topurchase the shares at the offering price. It is oftenthe case that underwriters and dealers will distributemost of the shares in the IPO to their institutionaland high net-worth clients, such as mutual funds,hedge funds, pension funds, insurance companiesand high net-worth individuals. For the typicalinvestor, being able to directly buy in a popularIPO is a unique opportunity.nThe other way, which is more common in the caseof individual investors, is to purchase the shareswhen they are resold in the public market in thedays following the IPO. An investor could place anorder with his or her broker to purchase shares inthis manner.How do I learn about the company?A company undertaking an IPO discloses requiredinformation in the registration statement, typically onForm S-1. Form S-1 and its amendments, which aredenoted as S-1/A, are filed with the SEC and publiclyavailable through the SEC’s EDGAR database at www.sec.gov/edgar/searchedgar/webusers.htm. Commentletters issued by the staff during the course of an IPOfiling review are also made available on EDGAR, butthey are not posted until at least 20 business days afterthe registration statement is declared effective.Most of a Form S-1 is comprised of the prospectus,which contains important information about thecompany. A new public company typically has no priorreporting history, and the information that can informa decision to invest often can only be found in theprospectus, although, if it has sold securities in relianceon an exemption, the company may have filed one ormore notices on Form D.Being well informed is critical in deciding whetherto invest. Therefore, it is important to review theprospectus and ask questions when researching anIPO. Whenever possible, verifying the informationyou are given against independent sources is alsorecommended. If you buy directly in an IPO you willreceive a copy of the prospectus before your brokerconfirms your sale, but you can also read the prospectusbefore then by reviewing the prospectus included in thecompany’s most recent registration statement onInvestor Assistance (800) 732-03302www.investor.gov

information regarding the relative contributionto the company’s financial results from differentsignificant lines of business or operations in foreigncountries. In addition, Legal Proceedings, which isusually located at the end of Business, discloses thesignificant litigation involving the company.From the perspective of the company offering its sharesin the IPO, the higher the offering price, the morecapital the company can raise. The underwriters alsohave an interest in a high price not only to meet thecompany’s objectives, but also because their compensationis typically a percentage of the offering price.nnManagement offers biographical informationregarding the directors and executive officers ofthe company.Financial Statements and Notes providesstandardized financial reports on the company’sfinancial condition and performance. Emerginggrowth companies and smaller reporting companiesare required to include two years of audited financialstatements in their IPO prospectuses (compared tothree years for other companies conducting IPOs).In addition, immediately prior to the financialstatements is the auditor’s opinion that sets forththe independent auditor’s opinion of the financialstatements it audited.What else should I consider?Following are some things to consider when making aninvestment decision involving shares of a new publiccompany.Offering priceThe company and the underwriters make the decisionon where to set the offering price. The factors they willconsider in setting the price, as well as the terms of theunderwriting agreement between the company and theunderwriters, are discussed in the prospectus, usuallyunder the caption Underwriting or Plan of Distribution.It is important to understand that the offering price isdetermined by a mix of market conditions, analysis andnegotiation. Competing interests affect the determinationof the offering price.At the same time, the underwriters are responsible forselling the IPO and will want a price that is attractiveto the client-investors to whom they will be selling.Underpricing an IPO creates a discount for the initialinvestors, increases the demand for the IPO and helpsthe underwriters sell all of the available shares. Underpricingmay also affect how much, if at all, the stock’sprice rises on its first trading day. If there is a largeincrease, or “bump,” from the offering price during theinitial trading, the underwriter’s client-investors may besatisfied because the value of their investment will haveincreased. However, the company may be unsatisfied inthat case, as it might have been able to sell its shares at ahigher initial offering price and thereby raise more capital.Informing these competing interests are valuationanalyses of the company’s business and the “orderbook.” Valuation analyses, which can be conducted byunderwriters or potential investors, attempt to value acompany based on its revenues, customers, financialresults and other metrics. The “order book” is thecompilation of indications of interest that the underwritershave obtained from the client-investors theysolicited regarding the IPO. The order book lists howmany shares each client-investor would like to purchaseand at what price.All of the foregoing factor into the determination ofthe offering price. Whether you have an opportunityto participate directly in an IPO or are buying sharesin the open market, it is important to realize that theoffering price reflects a negotiated estimate as to thevalue of the company. The offering price may bearInvestor Assistance (800) 732-03304www.investor.gov

little relationship to the trading price of the securities,and it is not uncommon for the closing price of theshares shortly after the IPO to be well above or belowthe offering price.In addition, purchasing shares in the market immediatelyfollowing an IPO can be risky. Underwriters cansupport the trading price of the new issue in its first fewdays of trading with certain trading activities, includingpurchasing shares of the company. This is often done tokeep the trading price from falling too far below theoffering price. Once this support ends, the stock pricemay decline significantly below the offering price.Selling shareholdersExisting shareholders can sell their shares in the IPO iftheir shares are included in and registered as part of theoffering. Most large IPOs include only new shares thatthe company sells in order to raise capital. However, insome cases, shares held by existing shareholders areincluded in the IPO and the shareholders are called“selling shareholders.” The proceeds from the sales byselling shareholders do not go to the company andinstead go to the selling shareholders.The cover page of the prospectus details how manyshares are being sold by selling shareholders, if any.The company will also disclose the number of shareseach selling shareholder currently owns, plans to sell inthe offering, and will retain following the offeringunder Principal and Selling Shareholders or a similarlycaptioned section. Selling shareholders may include, inaddition to early investors seeking liquidity on theirinvestment, the company’s founders and management.Companies must disclose any position, office or othermaterial relationship each selling shareholder has hadwith the company within the past three years. It maybe worthwhile to discern the relationships the sellingshareholders have had with the company and whatproportion of their respective holdings is being sold.Limited trading volumeThe trading price of a new issue may be affected bya limited supply of shares in the market immediatelyfollowing an IPO. The shares being traded on the firstday are generally only shares that were sold in the IPO.All other outstanding shares, such as those held byfounders, early investors and employees that have notbeen included in the IPO, may often not be sold in thepublic market so soon after the IPO, either becausethey are “restricted securities” under the federal securitieslaws that can only be resold without registration undercertain circumstances, or because the existing shareholdershave entered into a “lock-up agreement” inwhich they agree not to sell their shares for a certainperiod of time, typically 180 days.Moreover, underwriter policies that discourage“flipping” also limit the number of shares sold in theIPO that may trade on the public market in the firstfew days or weeks of trading. “Flipping” is the termused to describe the act of immediately reselling theshares acquired in an IPO through the open market.Underwriters may discourage flipping by refusing toallocate IPO shares to customers who have flippedshares in the past, but the practice of flipping, alone,is not prohibited under the federal securities laws.These restrictions, lock-up arrangements and underwriterflipping policies all serve to limit the numberof shares that trade in the public market immediatelyfollowing an IPO. The resulting limited tradingvolume, particularly in the case of a highly soughtafterIPO, can operate to drive the trading price ofan issue steeply up because of the limited supply tomeet the high demand.Market overhangThe number of shares that are outstanding but cannotbe traded at the time of the IPO is sometimes referredto as the “market overhang.” The share price after anInvestor Assistance (800) 732-03305www.investor.gov

IPO may decline over time as shares that were previouslyrestricted become available for sale. In addition, whenlock-up agreements expire, the share price may declinesignificantly if a large number of shares become availablefor sale all at once. Early investors and shareholders ina company often view an IPO as an exit strategy—away to realize a profit on their investment by beingable to sell shares to the public. The lock-up expirationsgive these early investors the opportunity to sell theirshares to the extent they weren’t able to do so asselling shareholders in the IPO.An investor can discover the extent of a company’smarket overhang in the IPO prospectus. A companymust discuss the shares that it has agreed to register forsale or that will be available for sale without registrationfollowing the IPO. This disclosure can typically be foundunder Shares Eligible for Future Sale or a similar caption.Dual-class common stockAn increasing number of companies engaging in IPOshave created separate classes of common stock with oneclass having greater voting power than the class beingsold in the IPO. This dual-class common stock structureis often used by companies that are family-controlledor will continue to be led by their founders, with the“super-voting” common stock held by the founders orcontrolling family. With this structure, the holder ofthe super-voting common stock has a much greaterpercentage of the voting rights in the company than hisor her equity stake would otherwise provide and cancontrol the company without owning a majority of itsshares. Generally, the super-voting common stockconverts to the lesser-voting class of common stockwhen sold by its initial holder. While many successfulcompanies maintain a dual-class common stockstructure, investors should be aware that such astructure may make it more difficult, if not impossible,for public shareholders to exert any influence orcontrol over corporate matters.Investors in new public companies can determinewhether a company maintains a dual-class common stockstructure and the rights they will have as shareholdersby reviewing the first page of the prospectus as well asthe section entitled Description of Capital Stock.Stage of the companyAn IPO is a significant milestone for a company,and high-profile IPOs frequently include companiesthat have exhibited recent tremendous growth anddevelopment. However, companies at different stagesof development engage in IPOs for various reasons.Often, a company is seeking to access the capital marketsin order to fund future growth and expansion. In otherinstances, a large and mature business may be returningto the public market after a successful reorganizationunder bankruptcy. It is important to keep in mindthat an IPO does not always represent an opportunityto invest at an early stage with a fast-growing company.Emerging growth companiesOne thing to keep in mind before investing in an IPOis that many disclosure and other requirements thatnow apply to public companies are phased in over timefor what are called “emerging growth companies.”Emerging growth companies generally have less than $1billion in revenue. A company will remain an emerginggrowth company for up to five years after becoming apublic company, unless its revenue exceeds $1 billion orit exceeds certain other thresholds.nEmerging growth companies may elect to have thesame extended periods of compliance that may beavailable for private companies to implement anynew or revised accounting standards. This meansthat other public companies may have to implementnew or revised accounting standards before emerginggrowth companies do. Emerging growth companieswill have to disclose whether or not they are electingInvestor Assistance (800) 732-03306www.investor.gov

nnnnto take advantage of the extended complianceperiods. When you compare an emerging growthcompany’s financial statements to those of othercompanies, you should keep this potential differencein mind.Emerging growth companies are not required tohave their auditors annually assess their internalcontrols over financial reporting. Other publiccompanies that are not emerging growth companieshave up to two years after their IPO before they arerequired to have their auditors assess their internalcontrols, and smaller reporting companies areexempt from this requirement. After the IPO,management of emerging growth companies willhave to assess the effectiveness of internal controls,like other public companies, but a separate auditor’sassessment of such controls is not required.Emerging growth companies do not have to discloseas much about executive compensation as otherpublic companies.Emerging growth companies do not have toconduct shareholder advisory votes on executivecompensation arrangements, such as “say-on-pay”and “say-on-golden parachutes” votes.Brokers and dealers, including underwriters whoare participating in an emerging growth company’sIPO, are allowed to provide research reports regardingemerging growth companies prior to, during andafter the IPO registration process. These researchreports may not present all the information requiredin a prospectus filed with the SEC and arenot subject to the stricter liability standards for aprospectus. Investors should keep in mind thatbrokers and dealers participating in the offeringmay face a conflict of interest between theirobligation to provide their research clients with anbalanced research report on a company and theirdesire to facilitate a successful offering on behalfof the company, which is their investment bankingclient or potential client.A research report can provide useful information,but as a general matter, you should never rely solelyon a research report. You should also do your ownresearch—such as reading the prospectus—todetermine whether a particular investment isappropriate in light of your own financialcircumstances.Additional InformationFor information on how to search for companydocuments, such as prospectuses and registrationstatements, in the SEC’s EDGAR database, visitinvestor.gov/researching-managing-investments/researching-investments/using-edgar-researchingpublic-companiesand www.sec.gov/investor/pubs/edgarguide.htm.For our investor alert about Pre-IPO InvestmentScams, visit www.investor.gov/news-alerts/investoralerts/investor-alert-pre-ipo-investment-scamsupdated.For information about Analyzing Analyst Recommendations,visit www.sec.gov/investor/pubs/analysts.htm.For information about being able to directlyparticipate in an IPO, visit www.sec.gov/answers/ipodiff.htm and www.sec.gov/answers/ipoelig.htm.For more information about IPO lock-up agreements,visit www.sec.gov/answers/lockup.htm.Investor Assistance (800) 732-03307www.investor.gov

For more information about IPO and post-IPOpricing disparities, visit www.sec.gov/answers/ipopricing.htm.For our investor bulletin about Say-on-Pay andGolden Parachute Votes, visit www.investor.gov/news-alerts/investor-bulletins/say-pay-golden-parachute-votes.For our investor bulletin on How to Read a 10-K,which summarizes information that companies providein annual reports on Form 10-K, visit www.investor.gov/news-alerts/investor-bulletins/howread-10-k.For additional educational information for investors,see the SEC’s Office of Investor Education andAdvocacy’s website for investors, www.investor.gov.The Office of Investor Education and Advocacy hasprovided this information as a service to investors.It is neither a legal interpretation nor a statementof SEC policy. If you have questions concerningthe meaning or application of a particular law orrule, please consult with an attorney who specializesin securities law.SEC Pub. No. 133 (2/13)