The IPO procedure is necessary for the successful and rapid withdrawal of the company’s shares to the stock exchange. The stock market is an integral part of the modern global financial system. Without the IPO procedure, securities trading would be impossible. After all, in order to buy and sell shares, you must first issue them. The IPO procedure, which will be discussed in the article, is responsible for this.
What is an IPO?
Initial Public offering (IPO) is the initial public offering of securities on the stock exchange when they are purchased directly from the issuer. The company receives money, and investors receive a share in the business and the possibility of further earnings on the growth or fall of the exchange rate.
The IPO procedure is usually carried out in order to attract finance for development. Sometimes this is done by companies with a position and reputation that have been on the market for a long time, but want to expand or launch a new project. Then there is a transformation, for example, of an LLC into an NPAO.
Often the initial offer is carried out by young startups, which are based on a fresh idea or know-how, for example, in the field of high technology or the Internet environment. To realize their plans, the company needs money, and the initial placement is one of the main types of their receipt.
What does an IPO give to a business?
A successful joint-stock company benefits both investors and the state. Successful placement of securities also brings great benefits to the company itself:
- the proceeds can be used to increase working capital, invest in new developments or reduce the debt burden.;
- business value increases due to liquidity and availability of available information;
- providing a share in the issue is a powerful motivation for key employees of the company. After all, now their own well-being depends on its development;
- entering the stock exchange helps to gain fame and international recognition, which will have a positive impact on the pace of business development.
Negative aspects
After entering the stock exchange, the company turns into a public one:
- investors will “press” the company’s top managers, expecting rapid business development. In addition, they will have to report to them regularly, which takes a lot of time;
- competitors can buy up a controlling stake with the aim of an unfriendly takeover of the business;
- The process of preparing for the IPO procedure requires a lot of time and effort. At the same time, managers may simply not have enough “gunpowder” to solve current business problems, which will not have the best effect on the state of the business.
The initial offer is a serious enterprise. Therefore, in order to avoid the problems listed above, it is important to realize all the complexities of the process and correctly calculate the time required for preparation.
IPO procedure
The IPO procedure is a long and costly affair. On average, it takes about 200 thousand dollars. Usually the IPO period is from four months to a year. If successful, all expenses will repeatedly pay off. Thus, such a step is usually preceded by a long and serious preparation.
Preliminary stage — capitalization assessment
The need for money does not mean that someone will give it. The company needs to understand that its issue will be successful. Therefore, the IPO is preceded by a long analysis:
- the degree of the enterprise’s prospects:
- the availability of innovative products or services;
- income growth indicators;
- does the management have sufficient experience and qualifications to competently conduct the entire IPO procedure, even with the help of consultants;
- company recognition — are its products known and how is their promotion going;
- will the sale of shares bring such a significant benefit to “recapture” costs;
- to what extent the current financial and economic situation is favorable for the initial placement.
Such an analysis takes a lot of time — sometimes more than one year. If everything is fine, then it is necessary to determine the capitalization of the enterprise, i.e. its value expressed in the number and denomination of securities.
It is not easy for business owners to do this competently and objectively. Most often, at this stage, they conclude an agreement with a so—called “underwriter” – in fact, a broker. This is usually an investment bank with experience in IPO procedures, which manages all subsequent work.
Underwriters
The underwriting contract on the stock market consists of one of the following options:
- Best efforts — sale of the maximum number of shares. At the same time, the broker does not bear financial responsibility — he acts, in fact, as a hired seller and consultant;
- Firm commitment — the underwriter buys the entire volume of securities issue from the company and issues them to the stock exchange independently. Of course, with a margin and having previously assessed their possible liquidity. In this case, the underwriter takes full responsibility for how the IPO goes, but can make good money on speculation.;
- The stand-by option is similar to the previous one, but the securities are repurchased in parts to keep their price in a certain range;
- All or none — the broker undertakes to realize the entire volume of the issue at the set price.
Sometimes an advance payment of the issuer is required — in case of lack of finances, the company takes a loan from the underwriter, committing to pay off the profit from the sale of shares.
In Russia, any legal entity accredited by the Central Bank has the right to engage in such activities. But often, especially with large issues, companies turn to several underwriters at once.
Those, in turn, conclude contracts among themselves, temporarily uniting into a syndicate. This gives a greater concentration of efforts on the implementation of the issue and reduces the risks of the underwriters themselves.
IPO procedure — preparation for entering the stock exchange
The underwriter evaluates the business and decides how many shares to issue, at what price they should be sold and when to enter the market. He is also engaged in a preliminary search for buyers who are ready to purchase securities even before the placement.
After that, an investment memorandum is drawn up — an important document intended for the supervisory authority of the country in which the procedure takes place.
For example, in the Russian Federation it will be the Bank of Russia, and in the USA it will be the SEC (Securities and Exchange Commission). The memorandum contains the following information:
- data on the company’s top managers and potential shareholders;
- financial statements;
- planned dividend payment policy.
The memorandum also prescribes for what purposes the proceeds will be used. If the content of the document suits the supervisory authority, the date of the IPO is determined.
After that, it is the turn to launch an advertising campaign to attract potential buyers. Business leaders make a kind of “tour” of the largest financial centers.
Such a trip is called a “Road Show”. During it, employees of the future issuer hold meetings with representatives of investor companies, presenting their business and revealing the benefits of possible investments.
The IPO procedure is the main stage
If the “roadshow” is a success, potential investors immediately submit applications. They indicate the number of shares and the price that future buyers are willing to pay. If the demand is small, the initial value of the securities is sometimes adjusted.
The underwriter summarizes the collected wishes and calculates how much investors are willing to purchase before the official placement.
After that, the securities are issued to buyers, and the remaining volume is put on the stock exchange. As a rule, if the underwriter does not buy the entire issue himself (the Best efforts agreement), he seeks to find an investor who will take most of it, thereby confirming the price.
The IPO procedure is the final stage
At this stage, the shares go into “free float” on the stock exchange, where their rate will depend on the success and advertising talents of the company, volatility and many other factors. There is a “listing” — the inclusion of securities in the register of assets traded on the stock exchange.
This stage puts all the dots over the “i” in terms of the real value of the issue. If the purchase of IPO shares from the market is successful at the opening, the issuer can exhale and start making plans for the future.
There is also the so-called “lockup period”. This is the period of time after entering the stock exchange, during which insiders (i.e. owners or employees of the company, as well as investors who bought shares before the opening of trading) cannot participate in the auction. By changing the exchange rate on the first day after the end of the lock-up period, the success of the IPO is also often judged.
IPO Regulation in Russia
It is worth starting with the fact that the concept of “IPO procedure” does not exist in the legislation of the Russian Federation. The most approximate definition is “public placement of securities”. The basics of regulating the IPO procedure are contained in two regulations:
- Federal Law No. 208-FZ of December 26, 1995 “On Joint-Stock Companies”;
- Federal Law No. 39-FZ of 22.04.1996 “On the Securities Market”.
But these documents contain only general concepts. In more detail, the process of issuing securities has always been regulated by regulatory acts issued by supervisory authorities.
From 1996 to 2004, the Federal Securities Commission acted as such a body, then until 2013 — the FSFR. After its abolition, the powers were transferred to the Bank of Russia.
During this time, the regulatory framework governing the issue of securities has changed many times. Still, the IPO procedure itself has been ignored by legislators for a long time.
First initiatives regarding IPO regulation
In 2003, changes in regulations came into force, which allowed holders of previously acquired securities to sell them to an indefinite circle of persons.
To do this, it was enough to register an investment memorandum (issue prospectus) and disclose certain information. In fact, it was an IPO of already issued shares. But many problems remained unresolved.
The main issue was whether the shareholders had a pre-emptive right to repurchase the securities offered on the stock exchange, which is enshrined in articles 40 and 41 of Federal Law No. 208. This rule did not take into account the practice of initial placement at all — investors had to wait for the expiration of the pre-emptive right.
Also, in accordance with Federal Law No. 39, the issuer is obliged to register with the supervisory authority a report on the results of the issue, which, according to Article 25 of the Law, can be considered for up to 2 weeks. At this time, the sale of acquired shares is prohibited. While the opportunity to make money on the difference between the placement and sale price is one of the main incentives for an investor.
In addition, if violations are detected during the issuance of securities, the supervisory authority can generally “wrap up” the report. Then the entire issue will be invalidated — naturally, with tragic consequences for the company.
Life-saving changes
The solution of the problems described above was facilitated by the adoption of Federal Law No. 194-FZ on December 27, 2005. This regulatory act allowed Russian firms to conduct IPOs according to rules close to developed Western countries:
- The validity period of the pre-emptive purchase was reduced from 45 to 20 days. At the same time, the company issuing shares is given the right to set the price of securities after the end of this period;
- it was allowed to carry out the issue without registering a report on the results of the issue.
Following this, the FSFR amended its regulations regulating the issue of securities in detail (Order No. 06-6/pz-n of January 12, 2006). The innovations concerned mainly the standards of information disclosure by the issuer.
Subsequently, the FSFM took a number of other measures to improve the climate of the Russian stock market in order to increase its attractiveness for IPO.
In general, Russian financial legislation is now aimed at simplifying the IPO procedure. On January 1, 2020, Federal Law No. 514-FZ came into force, significantly facilitating exchange processes, including the initial offer.
The changes he makes continue the trend laid down by Federal Law No. 194, adjusted for modern realities. For example, documents for registration of the issue can now be submitted electronically.
Examples of successful IPO placement in 2020 in Russia and in the world
Although the stock market of the Russian Federation is much more modest than the Western one, there are several quite successful examples of IPOs of Russian companies:
- Tinkoff Bank (TCS Group). The auction was held on the London Stock Exchange. At the moment, the share price has increased more than 3 times due to the rapid growth of the bank’s profits, its own ecosystem and high profitability;
- Extremely successful IPO of 2020. Conducted on NASDAQ in the USA. By the end of the first day of trading, the growth of shares was 34%, and at the moment they have almost doubled in price. The success is due to the heyday of online commerce during the period of restrictions imposed due to the pandemic;
- GC “Airplane” (housing construction). In the wake of increased demand for apartments thanks to a preferential mortgage, the exit procedure was a great success. An additional incentive was given by the introduction of escrow accounts to protect the funds of home buyers. At the time of the DDU, builders had to sell apartments at the excavation stage at a low price. Now the apartments are sold ready—made – of course, much more expensive.
- Sovcomflot is the largest Russian shipping company. The procedure took place in October 2020 on the Moscow Stock Exchange. The amount of proceeds does not pull on a record — $ 500 million, but it was the first full-fledged IPO in Russia since 2017.
According to many experts, Sovcomflot shares are a profitable long—term investment. Which is not surprising, because the company specializes in sea transportation of oil and gas — and this speaks for itself.
In addition, Sovcomflot intends to pay investors at least half of the annual profit. Such a dividend policy cannot fail to attract buyers.
Record IPO procedures in the USA in 2020
The coronavirus pandemic and related restrictions have had a significant impact on many global companies that were going to IPO in 2020. Someone revised their plans, but many still decided not to back down and achieved success:
- The American service of short-term rental housing for travelers can be called a record holder for the growth of the share price and the funds raised. From December 9 to December 31, 2020, securities rose by 116%, and almost $ 3.5 billion was raised during the IPO procedure. And this is despite all the restrictions that have hit the tourism sector hard;
- The successful IPO in the wake of anti-bullying measures made American students, who founded a food delivery service in 2013, billionaires. On the first day of trading, the growth was 85%, and the funds raised were $3.37 mld. Which is not surprising, since the demand for food delivery services has increased several times due to the pandemic;
- Snowflake is the developer of a cloud platform that allows you to organize disparate data. According to the results of the IPO, more than $ 3 billion of investments were received. On the first day of trading, the shares jumped by 111.6 %;
- Warner Music. Appearing as part of Warner Bros. In 1958, this largest recording studio soon separated and healed on its own. The Beatles, Linkin Park, Led Zeppelin are not a complete list of the concern’s world—famous clients. Here, the results of the IPO are more modest than those of previous companies, but still impressive. Revenue amounted to $1.93 billion, and the growth of shares from June to December was almost 57 %;
Only the most high-profile procedures conducted on the NASDAQ and the New York Stock Exchange are given. In total, 472 issuers made an initial offer in the USA in 2020.
The next IPO on the American market in 2021
The Russian chain of healthy food stores “VkusVill” is going to hold a public offering on the NASDAQ stock exchange in the fall of 2021. Now the company has already been transformed from an LLC into a joint-stock company with an increase in the authorized capital by 200 times.
Also, an IPO of Aspire Global Inc., a company engaged in developments in the field of electronic cigarettes, is expected in the American market. The auction will also be held on NASDAQ.
On July 1, Robinhood Markets submitted an application for the placement of shares. Interestingly, the company itself is a broker and has developed a mobile application for trading stocks without commission.
IPO market in Russia and the USA — comparison
The first public offering (IPO) in the history of the United States was held in 1783 by Bank of North America. The heyday of the American stock market occurred in 1960-2009. During this time, more than 12 thousand IPO procedures have been carried out.
The largest issue of shares on the New York Stock Exchange in the history of the country was held in 2014 by the Chinese trading firm Alibaba Group Holdings Ltd. The result was more than $25 billion of attracted investments. Now in America, an average of 200 IPO procedures are carried out per year.
In Russia, Vimpelcom became a pioneer, placing shares in London in 1996. And it was only in 2002 that RBC Information Systems entered the domestic stock market for the first time.
From 2003 to 2007, we can call the heyday of the Russian IPO market — more than 50 procedures took place in Moscow. It is from this moment that the stock market of the Russian Federation begins to be taken seriously. Placement of shares in Russia is less expensive, and the legal requirements are not as strict as in the USA.
Yet, even Russian issuers often prefer to be located in America and the European Union. The last two IPO procedures on the Moscow Stock Exchange took place in 2017 (Globaltruck) and 2020 (Sovcomflot).
In 2016, 50 times fewer IPO procedures were conducted in Russia than in the USA. The reason for such low activity lies in the current instability of the Russian economy.
The crisis of 2008, the beginning of sanctions in 2014 — all this does not add enthusiasm to business.
Naturally, in such conditions, companies are trying more to attract foreign capital. Therefore, it is not surprising that the Russian IPO market is still inferior to both American and European.
Conclusion
Despite the fact that, historically, the United States is about 900 years younger than Russia, the United States has moved far ahead in the development of finance. This is not surprising — after all, the formation of the business environment in America went on continuously. Even the Civil War did not prevent it. What can we say about other Western countries whose financial systems are rooted in the deep Middle Ages.
In Russia, the state system has been changed twice over the last century. At the same time, for almost three quarters of a century, the word “business” was almost a curse, and the first decade of the existence of the Russian Federation was more like a “dogfight” for the riches of the former Union.
However, in general, legislative trends in the regulation of the stock market of the Russian Federation inspire optimism. Any government is interested in foreign investment, and the Russian government is no exception. One can hope that the most successful IPO procedures on domestic exchanges are still ahead.
