How investment bank helps in Initial public offering.

 INTRODUCTION 

IPO: Initial public offering means the process where a private company offers its share to public and get itself listed in stock market for the very first time so public can buy stake of the company.

The History of IPO:

The initial public offering has been a buzzword on Wall Street and among investors for decades. The Dutch are credited with conducting the first modern ipo by offering shares of the Dutch East Indian Company to the general public.Since then IPO has been used as the way of raising capital from public.

Investment banking: investment bank underwrite new debt and equity security for all types of corporation, aid in sale of securities and help facilitate merger and acquisition. Its activities also includes issuing security as means of raising money through ipo and serves as middlemen.

There are two terms: First is, investment banker and the other one is, investment banking. Investment banker is a professional who helps companies to raise capital by issuing stocks and offering bonds. He assists companies, corporations, governments and other entities and provide financial advice to them. On the other hand, Investment banking is a segment of bank operations which helps in organising large financial transactions such as merger or IPO. 

Now that we know about the difference between the two terms, let’s talk about the role of an investment banker:

• He advises entities on financial matters and assists with financial transactions such as merger or acquisition.

• He helps to raise capital by issuing stocks and offering bonds.

• They also create Securities and Exchange commission (SEC) which is a regulatory body that protects investors and is necessary for companies to go public.

• He is a risk management expert for the company. He identifies risk before every single step a company wishes to take.

• Non-profit organisations seek help from investment bankers for planning their company’s future growth and development.

When a company holds its IPO, at that time the investment bank purchases almost all the shares of the company and acts as a bridge between the company and the public. The investment bank sells the company’s shares to the public on a price higher than the purchase price to generate profit.

Let’s understand this by taking an example:

Suppose there is a company named, Cash Trading Company which wants to go public. So the owner of the company, Mr. Mahesh Prasad Agarwalla will get in touch with Sairaj Agarwalla (an investment banker). They both will have a deal and Sairaj(on behalf of his firm) will agree to purchase shares(suppose 1000) on Rs.20 per share. 

Now Sairaj’s company will pay Rs. 20000 to Cash trading company. On the day of IPO, the company will sell the shares at Rs.22 per share to generate profit. If the market supports the price, then Sairaj’s company will have a profit but if the market is weak, then the company will have to sell the shares at a reduced price which means they will incur a loss.

This will not affect cash trading company at any means because it has already got its Rs.20000.

Skills required by an investment banker:

1. Investment bankers should be very efficient with numbers as much of their works involves numbers only.

2. They must have great communication skills so that the language they will use to communicate and revert their ideas to the client will be understandable and professional.

3. He should also possess prominent presentation skills for better understanding of the clients.

4. He should have a finance background in education so as to have knowledge about financial analysis, annual reports, etc.

5. He can also have a specialised knowledge on a particular industry which will provide better advices and insights to the client on financial matters.

6. He must develop the capacity of working for long hours as and when required.

Examples of investment banker– Goldman Sachs, JP Morgan Chase, Morgan Stanley, etc.

Investment banker can act as:

• Financial advisor: Understands how a client wishes to use his money and advices him accordingly by providing financial models.

• Financial Planner: Plans the investment and budgeting of the company like where to invest and how much to invest.

• Account manager: He is someone who directly deals with the clients so his duty is to maintain healthy work relationship with clients.

• Certified Management Accountant (CMA): He has in-depth knowledge about financial planning and financial modelling so it will provide better assistance to clients.

Investment banker plays a vital role in today’s world and his job is pivotal. He can act as a different person in different situations according to the needs and requirements of the client. He helps companies to raise capital and provide them insights where to invest and where not to.

Role of investment bank in IPO process

–Underwriting

It act as the underwriter which means they agree to buy of specified shares of the company at a set price and sell them to the public.

-Due diligence 

Investment bank are made responsible to conduct the due diligence of the company and make report of the same and reviewing it’s  financials, operations, and legal compliances.

–Valuation

Investment bank help determine the valuation of the company by analyzing it’s financial performance, industry trends and comparable companies as this is very important before the initial public offering.

–Regulatory compliance

Investment bank help companies to do the regular compliances which are necessary before going public such as filing of documents with the regulatory authority which is securities and exchange board of India. They help draft prospectus.

• Pricing 

Investment bank in accordance with valuation of company decides the price of the IPO and it also considers the market demand and conditions.

The process of initial public offering (IPO)

Step 1: Select an investment bank

The first thing which issuing company do is to choose the investment bank which will provide underwriting services.

Underwriting is the process through which an investment bank act as broker between the issuing company and pubic to sell it’s initial shares.

Step 2: Due diligence and regulatory filings

The underwriter has the responsibility to draft the documents which are engagement letter, which typically includes: 

Reimbursement clause– this clause contains that that issuing company must cover all the out of pocket expenses incurred by underwriter during the due diligence.

Gross spread/underwriting discount– Gross spread is arrived at by subtracting the price at which the underwriter purchases the issue from the price at which they sell the issue.

Letter of Intent– this clause basically contains the commitment between underwriter and issuing company to enter into contract.

A commitment by the issuing company to provide the underwriter with all relevant information and, thus, fully co-operate in all due diligence efforts.

An agreement by the issuing company to provide the underwriter with a 15% overallotment option.

Registration Statement– consists of information regarding the IPO, the financial statements of the company, the background of the management, insider holdings, any legal problems faced by the company, and the ticker symbol to be used by the issuing company once listed on the stock exchange. 

The registration statement has basically two parts:

The Prospectus: A prospectus is a formal legal document that provides detailed information about an investment offering to the public. This is provided to every investor who buys the issued security. It contains essential information about the company, including its business model, financial statements, risks, and the use of the funds raised through the offering

1. Preliminary Prospectus (Red Herring): Issued during the initial stages of the IPO process, it outlines key details about the offering but does not include the final share price or the exact number of shares to be offered.

2. Final Prospectus: Released after the IPO is priced, this document includes the final terms of the offering, including the price per share, the total number of shares offered, and any changes made after the preliminary prospectus.

Private Filings:  it is the confidential submission document which is not disclosed to public immediately and this is provided to Securities and Exchange commission (SEC).

Step 3: Pricing

After the prospectus has been approved by SEC the effective date is decided. On the day before the effective date, the issuing company and the underwriter decide the offer price (i.e., the price at which the shares will be sold by the issuing company) and the precise number of shares to sold.

IPOs are often underpriced to ensure that the issue is fully subscribed/ oversubscribed by the public investors.

If an IPO is undersubscribed the underwriter take the shares. Furthermore, underpricing compensates investors for the risk that they take by investing in the IPO. An offer that is oversubscribed two to three times is considered a good IPO.

Step 4: Roadshow and Marketing:

The investment bank organizes a roadshow, where the company’s executives present the business and growth potential to institutional investors (mutual funds, pension funds, etc.). The goal is to generate interest and gauge demand for the IPO.

Marketing the IPO: The investment bank markets the IPO to potential investors, explaining the company’s growth potential and why they should invest.

Step 5: Stabilization

After the issue has been brought to the market, the underwriter has to provide analyst recommendations.

The underwriter carries out after-market stabilization in the event of order imbalances by purchasing shares at the offering price or below it.

Step 6: Transition to Market Competition

The final stage of the IPO process, the transition to market competition, starts 25 days after the initial public offering, once the “quiet period” mandated by the SEC ends.

During this period, investors transition from relying on the mandated disclosures and prospectus to relying on the market forces for information regarding their shares. After the 25-day period lapses, underwriters can provide estimates regarding the earning and valuation of the issuing company. Thus, the underwriter assumes the roles of advisor and evaluator once the issue has been made.

Hence the market price of the IPO is considered to be successful if the difference between the offering price and the market capitalization of the issuing company 30 days after the IPO is less than 20%. Otherwise, the performance of the IPO is in question.

Conclusion:

 Investment bank plays a critical role in IPO process by guiding the company with best alternatives and they act as underwriters, helping the company raise capital by selling shares to the public, while also providing expertise in pricing, regulatory compliance, and market strategy.

Through their deep understanding of financial markets and investor behavior, investment banks help ensure a successful IPO by balancing the company’s goals with market conditions. They also continue to offer post-IPO support, helping newly public companies navigate the challenges of being listed on a stock exchange.