{"id":4206,"date":"2013-11-07T06:30:37","date_gmt":"2013-11-07T14:30:37","guid":{"rendered":"http:\/\/canary.kcprod.info/blog\/?p=4206"},"modified":"2022-01-11T17:12:41","modified_gmt":"2022-01-12T01:12:41","slug":"behind-the-scenes-on-the-day-of-a-companys-ipo","status":"publish","type":"post","link":"https:\/\/canary.kcprod.info/blog\/behind-the-scenes-on-the-day-of-a-companys-ipo\/","title":{"rendered":"Behind the Scenes: The Day of a Company’s IPO"},"content":{"rendered":"

E<\/span>xcitement has been building in advance of today\u2019s Twitter IPO and it has led a number of our readers to request that we add a new chapter in our popular IPO 101 Series<\/a>. Specifically they\u2019ve asked for a behind-the-scenes view of the action as it unfolds<\/em> on IPO day.  What follows is a step-by-step description of these events.<\/p>\n

Who makes the decisions?<\/h2>\n

Things actually kick into high gear at the end of the business day prior<\/i> to the first day of trading.  That is when the \u201cpricing committee,\u201d a subset of the board of directors, meets with representatives of the managing underwriter. Pricing committees are often comprised of the company\u2019s CEO, CFO and typically at least one non-management member of the board who has experience in IPOs. The managing underwriter is the investment bank receiving top billing during the IPO; its name is displayed on the top left of the list of bankers on the prospectus cover. In Twitter\u2019s case the managing underwriter is Goldman Sachs (as if you could have missed it).<\/p>\n

How is the price set?<\/h2>\n

At this meeting, the investment bankers share all the information they have collected on the demand for the offering.  The CEO and CFO typically have spent the prior 2 \u00bd weeks engaging in one-on-one meetings with up to 60 institutional investors.  The sales team from the investment bank collects the number of shares each institutional portfolio manager would like to buy at particular prices.  Based on this information the \u201csyndicate manager\u201d or \u201ccapital markets desk manager\u201d of the lead investment bank recommends a price at which the company\u2019s stock should be sold.<\/p>\n

Prior to the Facebook offering, bankers typically recommended selling shares at a 10 \u2013 15% discount to the multiples of sales and earnings for the most comparable public companies.  I am told by knowledgeable sources that since the Facebook offering, the discount has been increased to up to 30% to ensure the company\u2019s shares don\u2019t trade below the offering price.<\/p>\n

Bankers and management teams don\u2019t like shares to trade below the offering price because it will be perceived as a failed offering. That scenario usually causes management to spend an inordinate amount of their time explaining why their business isn\u2019t flawed just because their price dropped relative to its offering price.  And this would be a shame given all the work that went into delivering a positive outcome. While the management team has the ultimate call on the price, the bankers will strongly weigh in if management chooses too<\/em> aggressive a price.<\/p>\n

<\/b>How are the shares allocated?<\/h2>\n

Once the price has been set, the shares must be allocated among the investors.  The bankers try to allocate in such a way that they don\u2019t quite<\/strong><\/em> satisfy the demand of the most interested buyers.  This is intended to provide incentive to the under-allocated investor to fill out her position by buying in the aftermarket. Such demand helps fuel the rise in the stock post-offering.  Allocating too few shares to an institutional investor can cause them to sell immediately post-offering, since they didn’t get enough to build a meaningful position. This could cause an over-abundance of supply, and too much supply puts tremendous pressure on the price of the stock.<\/p>\n

Imagine a portfolio manager who runs a $2 billion mutual fund.  She typically doesn\u2019t want to own more than 200 different securities.  That means she must be able to build at least a $10 million position in each stock she owns. If she were allocated 2% of the Twitter offering (140,000 shares @ $26\/share) then she would only have a $3.6 million position.  Even with 30% appreciation she will only get to $4.7 million.  The bankers must then determine if she is willing to buy an additional $5.3 million position in the open market.  If it is determined that she will not, then her position must be increased to improve the odds of aftermarket demand or decreased and expected to be immediately sold.<\/p>\n

The (relatively small) role of the retail investor<\/h2>\n

Retail investors are not considered terribly attractive buyers because they seldom generate follow-on demand and are often not long-term holders.  As a result they are typically only allocated 10 \u2013 20% of the shares offered in the IPO.  In Twitter\u2019s case that would represent 7 to 14 million shares out of the 70 million shares offered. Consumer-focused companies often want to use the IPO as a branding event  by pursuing retail allocations at the top end of the range.  Enterprise companies typically pursue retail allocations at the bottom end of the range.  In Facebook\u2019s case the underwriters increased the size of the offering at the last minute and applied the vast majority of the increase to retail investors, which contributed to the weak performance of the stock post-offering.  Unfortunately it is almost impossible for companies to specifically allocate shares only to users or clients.<\/p>\n

As you can imagine allocating an offering is quite an art.  You want to make sure you allocate in such a way that certain investors buy in the aftermarket and other investors sell so as to create shares for others to buy.<\/p>\n

Matching buyers with sellers<\/h2>\n

The institutional investors who have been allocated stock are typically informed the morning trading begins.  And on the following morning the lead investment bank\u2019s sales team collects buying and selling demand from institutions that received shares in the offering and institutions that didn\u2019t.  Once again retail investors don\u2019t play much of a role in the process because of their relatively small demand compared to the institutions. It typically takes three to four hours for the capital markets desk to sort through all the possible permutations and combinations of purchases and sales to determine where to set the opening trade price such that there is an orderly market.  This is why IPO shares don\u2019t trade before 10 AM Pacific time (vs. the market open at 6:30 AM).<\/p>\n

The role of stabilization<\/h2>\n

Once the IPO shares are free to trade the investment bank must play a supporting role.  If shares trade up then the bank has the option to increase the offering by 15% at the IPO price to dampen the rise.  In Twitter\u2019s case this option represents another 10.5 million shares. The bank earns its commission on these shares and the company benefits from more proceeds.  This option is typically referred to as the \u201cGreen Shoe.\u201d  The term comes from the first company, the Green Shoe Manufacturing (now called Stride Rite Corporation), to permit underwriters to use this practice in an offering.  The Green Shoe, or just \u201cShoe,\u201d is exercised in the vast majority of IPOs.  If the stock begins to trade down then the managing underwriter is expected to use its own capital to jump in and buy shares to \u201cstabilize\u201d the price.  The increase in demand from this stabilization buying sometimes succeeds in driving the price back up.  The Shoe is available to the investment bank for up to 30 days and rewards the bank for taking the stabilization risk.<\/p>\n

The closing price doesn\u2019t matter<\/h2>\n

Most everyone is happy if the stock closes above the IPO price but the story does not end there.  Employees typically do not get to sell their shares until the underwriters\u2019 lockup is released 180 days after the close of the offering.  It is very important for the issuer to meet or exceed the revenue and earnings guidance it provides during its IPO roadshow.  As we explained in Real Data-Based Guidance On Selling Stock Post-IPO<\/a>, Wealthfront\u2019s research found the vast majority of companies who miss their guidance in one of their first two quarters as a public company seldom see their stock price rise above their IPO price at any time in the future.  It is therefore imperative for management to take a long-term view and not get overly hung-up on performance of their stock on IPO day.  It is extremely important that the issuer continue to perform well post-offering so it can build enough demand for its stock to absorb all the shares that flood the market when the employees and the investors are finally allowed to sell their shares.<\/p>\n

We hope this post gave you greater insight into what has traditionally been an opaque process. And please keep the requests coming in on issues of IPO interest.<\/p>\n","protected":false},"excerpt":{"rendered":"

Excitement has been building in advance of today\u2019s Twitter IPO and it has led a number of our readers to request that we add a new chapter in our popular IPO 101 Series. Specifically they\u2019ve asked for a behind-the-scenes view of the action as it unfolds on IPO day.  What follows is a step-by-step description […]<\/p>\n","protected":false},"author":4,"featured_media":7280,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"inline_featured_image":false,"footnotes":""},"categories":[1374,1315,1278],"tags":[1734,1723,1735],"coauthors":[99],"class_list":["post-4206","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-career","category-industry-insights","category-planning","tag-behind-the-scenes","tag-initial-public-offering","tag-twitter-ipo"],"acf":[],"yoast_head":"\nWhat Happens Behind the Scenes on IPO Day | Wealthfront<\/title>\n<meta name=\"description\" content=\"A behind-the-scenes view of the action as it unfolds on IPO day\u2014 share pricing, allocation, trading above or below the initial offering\u2014 how it all works.\" 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