Tue | Feb 18, 2020

Oran Hall | The anatomy of an IPO

Published:Sunday | April 21, 2019 | 12:20 AM


An initial public offering, or IPO, is the offering of shares in a company to the general public for the first time.

IPOs may be made by start-up companies or companies that have been in business for a long time and by companies owned by private persons, other companies and governments.

Companies ‘go public’ for several reasons: to raise capital to reduce or pay off debt, to fund growth initiatives, to raise public profile, to allow existing shareholders to convert their holdings of stock to cash and to broaden their ownership.

A successful IPO is generally followed by the listing of the shares of the company on the stock exchange if the company satisfies the conditions for listing, an action which facilitates the trading of the shares on the secondary market, thereby providing liquidity for them, as shareholders are able to sell any portion of their holdings to other interested parties.

Listing also provides a means for determining the market value of the shares and the market capitalisation of the company.

Listing on the stock exchange raises the public profile of the company as it trades on the market and makes the required public disclosures of its financial performance and other material information. Poor financial performance and failure to make the required disclosures on time as well as failure to abide by the rules of the stock exchange can do serious harm to listed companies.

Although investors stand to benefit from receiving dividends and seeing the price of their stock appreciate, there is no guarantee that the company will make a profit or that the price of the stock will appreciate. How well the company does rests heavily on the ability of management to steer it effectively in whatever environment it has to operate.

A major initial step in an IPO is the preparation and distribution of the prospectus, also called the offering document. From it, prospective investors should derive enough information to make an informed decision on the merits of the invitation to subscribe for shares in the company. It makes sense to study and analyse it thoroughly and carefully.

The prospective investor who is not sufficiently competent to make a decision should seek independent advice from a competent financial company or professional.

Prospectus as guide post

The prospectus generally carries a summary of its contents, thereby providing a good overview of what readers can expect to see in it. It identifies the issuer of the security, states the type of security being offered, its price, the amount being offered to the public, how to apply for them, the name and address of the lead broker and selling agents responsible for distributing them, the subscription period, and the overall minimum amount of the security required to be successfully made for the issue to be considered a success.

There is also a statement on the intention to apply for the security to be listed on the Jamaica Stock Exchange and one on the basis on which the security will be allocated and how refunds will be made in the event of oversubscription or the rejection of applications.

Perhaps the most important section is that which presents the financials of the company. This covers the most recent year and five or more historical years and provides enough data to allow for a reasonable analysis of the profitability and financial strength of the company.

Apart from the overall performance of the company, the performance of different lines of business may also be presented. In the case of new companies, statements are presented to show the projected profits and financial position of the company, but these should be treated with great care.

Another important section is the ‘Management Discussion and Analysis’ section. It discusses the management’s perspective of the company’s financial position and changes thereto, results of its operations, how and why its financial results have changed over the period covered by the financial statements and what might affect future performance.

The prospectus also addresses any pending litigation as well as potential risk factors that the management feels could significantly affect the company’s business, operations and performance.

Additionally, there is information on what the funds raised will be used for, biographical information on the directors and executive management and their ownership interest in the company, the interest of other major shareholders, the dividend policy of the company, the products, services, goals, corporate structure and key strengths of the company,

There is too much information available for prospective investors to make a decision on just emotion, publicity and promotion, and it should be borne in mind that although there is potential for meaningful short-term price appreciation, particularly when there is strong demand for the stock, investing is long-term in nature and offers no guarantee of success.

Oran A. Hall, the principal author of The Handbook of Personal Financial Planning, offers personal financial planning advice and counsel.