Initial Public Offering (IPO)

Initial Public Offering (IPO):
An Initial Public Offering (IPO) is the process of selling a company’s stock to the public for the first time. Before the IPO the company is private; after the IPO the company is public. The IPO process is typically underwritten by a syndicate of investment banks. The process follows several steps, described below.

Advantages and Disadvantages of IPO's:
Going public has at least two advantages:
>>Greater liquidity of equity and access to a larger pool of capital.

There are at least three disadvantages to going public:
>>Dispersion of control,
>>Required adherence to regulations and
>>Public scrutiny.

IPO Process:
The IPO process follows several steps:
1. The company chooses a syndicate of underwriters (see below).
2. The company and the underwriters compose a preliminary prospectus (see below).
3. The SEC reviews the prospectus and approves the IPO.
4. The underwriters determine the value of the firm and the structure of the IPO.
5. The underwriters go on a road show to gauge investor interest in the IPO (see below). 6. The investors express level of interest and the underwriters set the offer price.
7. The securities are distributed to the public (see below).

Underwriter Duties:
In the IPO process, the underwriters – a syndicate of one or more investment banks – are responsible for registering the IPO with the SEC, valuing the company that is going public, structuring the issuance of securities, pricing the securities, and marketing the securities to potential investors. The underwriters also bear the risk of distributing the securities.

Preliminary Prospectus:
The preliminary prospectus, or red herring, is a legal document that must be submitted to the SEC for approval prior to an IPO.

The document includes details about the company, including an explanation of the company’s operations and competitive position, and copies of its financial statements. The document also includes the details of the IPO, including the type of security (common stock, preferred stock, etc.) to be offered, the number of shares to be offered, and the anticipated share price.

Road Show:
A road show is when the underwriters travel the country, or the even the world, to pitch the IPO to potential investors. The idea is to determine whether investors are interested in the offering and, if so, to then determine how many shares they will purchase and what price they are willing to pay. The investors are typically large institutional investors – mutual funds and pension funds.


IPO Pop:
Underwriters take on significant financial risk when they commit to an IPO. If the market is not interested in the offering, the underwriters may be stuck holding securities that nobody wants.

In order to ensure market interest in the offering, underwriters will often deliberately under-price the securities for the initial public offering. They sell it for cheaper than it is worth. So when the shares go public, investors buy up the bargain-priced shares, causing them shoot up in value on the first day of trading. This is known as the “IPO pop.”

Insider Trading

Insider Trading Defined:
Insider trading is buying or selling stock based on nonpublic information that will affect the stock’s price. A company’s executives and directors have access to significant information regarding the company’s activities. These people could easily profit by buying or selling the stock based on the private information they have. However, doing so is illegal.

Insider trading, in certain circumstances, is prohibited by SEC regulations. The idea is that trading based on private information is unfair. If insider trading were legal, insiders could make huge profits by buying or selling a company’s stock just before important information is made available to the public. This behavior would put the investing public at a tremendous disadvantage in terms of buying and selling financial securities.

Insider trading is not always illegal. Typically, someone labeled an insider will have designated windows of opportunity throughout the year in which to legally buy or sell the company’s stock. Executives and managers are often awarded stock options, CEOs and directors often own significant amounts of their company’s stock. These people should be able to buy and sell their stock. And they can. But it must be done according to the rules. Insiders must notify the SEC regarding their buying and selling transactions.

Under certain conditions, if an executive announces publicly that he will sell a certain amount of shares or value of stock at a specified date every year, then he may do so each year without it being considered illegal insider trading. Likewise, managers or executives with access to nonpublic information may buy or sell stock after that information has been made available to the public.

Insider Trading Example:
For example, imagine an executive at a large publicly traded corporation who sees the company’s income statement before it is issued to the public via the annual report. The executive sees that the corporation suffered big losses in the current period. Once the Wall Street analysts see these numbers, the company will be downgraded and the stock will decline.

If insider trading were allowed, the executive could quickly go out and sell the company’s stock short, or else he could tell his broker and his friends and family members to sell the stock short. Selling a stock short makes a profit when the stock price goes down. When the reports are finally made public, the stock plummets, and the executive and his friends and family all make a lot of money. Meanwhile, the investors who owned the company’s stock but did not have access to the private information suffered losses.

Who is an Insider?:
Technically, an insider is anyone who has access to material nonpublic information regarding a company. Examples of insiders include executives, directors, managers, shareholders with a 10% or greater stake in the company, and the close family members of these people. Insiders may also include lawyers, brokers, investment bankers, and printers of financial documents. It is illegal for insiders to buy or sell a stock based on material nonpublic information.

What is Insider Information?:
Inside information is any material nonpublic information regarding a company that could affect the company’s stock price. The information is nonpublic if it has not yet been disclosed to the investing public. The information is material if its disclosure could impact the company’s stock price. Examples of insider information include access to unreleased earnings reports, knowledge of a pending or imminent takeover or merger, or knowledge of any other kind that is of value to investors.

Over the Counter Bulletin Board (OTCBB)

Over the Counter Bulletin Board (OTCBB) Definition: The Over the Counter Bulletin Board or OTCBB is an electronic quotation system used for smaller stocks that do not meet the credentials to be listed on the NASDAQ or National Securities Exchange.

Over the Counter Bulletin Board (OTCBB) Explained:
The OTCBB is a market for smaller companies that do not meet the market capitalization, minimum stock price, or other requirements that are needed to be listed on the larger exchanges. Because of the low share prices the stocks are often referred to as OTCBB penny stocks. The only requirement of the OTCBB listing requirements are that a company has to have audited financials following the requirements set forth by the SEC. However, OTCBB pink sheets are listings that do not have the proper SEC filings. Because they are not filing to the SEC pink sheets are often more risky than the other stocks listed on the Over the Counter Bulletin Board.

Over the Counter Bulletin Board (OTCBB) Example:
Wawadoo Inc. is a startup company that manufactures widgets for the market. Although it is a small company right now, management believes that the company has great growth potential. Management believes that it can be listed on the NASDAQ eventually, but it does not meet the requirements for now. Wawadoo has decided to go ahead and list itself on the OTCBB to establish the company in the market, and as it grows they will move into the larger exchanges.