IPO: Initial Public Offering

An IPO (Initial Public Offering) is the first offer of shares in a company for public purchase. It is therefore the initial public offering of a company. The shares of a company are listed on a capital market for the first time and made available to the general public. These are either shares from existing shareholders or newly issued shares as part of a capital increase.

If shares are issued by existing shareholders, they sell their shares and only the owner changes. In the case of a capital increase, the company receives new capital from the issue of new shares. But be careful here: There may be a dilution of capital for existing shareholders, as the individual shares already held by existing shareholders become worth less due to the increased capital from the new issue of shares.

Reasons for going public

Nevertheless, an IPO also offers many advantages. The reasons and motives for an IPO are therefore very diverse. The most important reasons are

• Capital requirements

Financing growth

Strengthening equity

• Succession planning
• Higher sales price

An IPO is primarily carried out in order to cover capital requirements and raise new funds. On the one hand, these can be used to finance growth, for example if a company wants to expand and build new factories. On the other hand, the financial resources may be intended to strengthen equity, e.g. if a company is heavily indebted.

Another reason for going public is succession planning. If, for example, several people inherit a company, an IPO is a good idea, because by selling the shares, each heir receives the same amount of money and disputes can be avoided.

In addition, when a company is sold on the public markets, i.e. on the stock exchange, a higher selling price can be achieved. If the company or its shares were only sold to a single investor, this investor would probably not be able to provide the entire purchase price. However, if the shares are sold via the stock exchange, the purchase price can be increased as several investors are investing at the same time.

Process of an initial public offering (IPO)

Once a company has decided to go public, there are still several processes to go through before the first shares can be issued on the stock exchange. The entire process takes about a year.

1) Examination of stock market readiness

The first step is to check whether the company is ready to go public on a legal and economic basis.

Legal stock market readiness

The basic prerequisite for an IPO is that the company has the legal form of a stock corporation. This can be either an AG, a European Company (SE) or a partnership limited by shares (KGaA). However, if a stock corporation does not yet exist, the existing company form must first be converted into a stock corporation in order to create the legally correct framework.

Economic stock market maturity

The economic readiness of a company to go public is understood to mean the economic suitability of a company to go public. This involves examining the turnover and profits generated by the company in question and the extent to which a future strategy exists for the company. In order to analyze this, internal company data is examined, an industry, product and competition analysis is carried out, a peer group comparison is made with companies already listed on the stock exchange and the strengths and weaknesses of the company are analyzed.

2) Selection of the underwriting bank

Once the company has been assessed for readiness to go public, the company must now decide on a suitable bank with which to carry out the upcoming IPO. To this end, various banks apply to the company as part of a so-called beauty contest. The company then selects one or often several suitable banks and appoints them as the syndicate bank(s). This means that the IPO is carried out jointly with this bank or consortium of banks. The costs involved are high, with bank fees usually amounting to around 5% of the issue volume.

3) Due diligence

This is followed by a wide-ranging due diligence review carried out by lawyers and auditors. The company's strengths, weaknesses, opportunities and risks are examined down to the smallest detail. The most important due diligence checks are legal and financial due diligence, in which both the legal and financial situation of the company are examined.

4) Research report

Based on the results of the due diligence checks, the syndicate banks then write a so-called research report. This summarizes the results of the due diligence review for potential investors. The research report includes

• a description of the market position
• a description of the market potential
• as well as analyses of the company value in order to be able to set the issue price

5) Roadshows

With this research report, the banks then go on roadshows with the aim of finding suitable investors. In most cases, a suitable group of investors has already been defined, e.g. employees, retail investors, financial sponsors or investment funds. Now the banks contact investors and try to convince them to buy shares in the company. To this end, the banks present the equity story (corporate concept and strategy) and their research report on the company to potential investors and use the data to try to convince them to invest.

6) Bookbuilding

The next step is the opening of the order books by the banks, also known as bookbuilding. Investors can now state their price and the number of shares they would like to buy. At the end of the roadshows, a certain price range usually emerges within which the subsequent issue price is set. This is then also communicated by the banks.

7) Subscription and allotment

Each investor now has the opportunity to submit an offer, specifying both his maximum price and the number of shares he would like to acquire. The order books are then closed. The final issue price is then determined by the banks on the basis of the closing bids and demand.

Once the issue price has been determined, the shares are allocated. All investors whose orders are below the issue price do not receive any shares. Those bidders who have submitted offers above the issue price will then receive their shares at the issue price, regardless of how high their original offer was. This is to ensure that every investor has to pay the same amount and that a fair starting position is created.

However, the shares may also be oversubscribed. This happens when more shares are in demand than the company has offered. In such a case, the underwriting bank has the option of drawing on a reserve pool, the so-called green shoe, and issuing additional shares.

8) Listing & Settlement

In the final step, the issue price is officially set and trading on the stock exchange begins. This is also known as the initial listing, as the company's shares now have a market price for the first time.

However, the services of the underwriting banks usually go beyond the initial listing. For example, price maintenance is usually carried out one month after the initial listing. Here, the underwriting bank tries to prevent price fluctuations by buying shares when the price falls and selling shares when the price rises. The aim is to keep the share price as stable as possible.

Other options than IPO

In addition to the Initial Public Offering, there are also other ways to list a company's shares on the stock exchange. These include direct listing, reverse takeover and SPACs.

Direct listing

With a direct listing, companies do not decide to issue shares, but merely offer existing shareholders the opportunity to sell their shares to the public. Consequently, there is no financial inflow in the form of a capital increase. The main advantage of a direct listing is the faster and more cost-effective processing, whereas IPOs are much more complex. There is also the advantage for existing shareholders that their shares are not diluted by a capital increase. However, due to the lack of pre-placement with investors, which takes place in the context of IPOs, there is great uncertainty regarding the first price quotation and the issue price. Here, no minimum price is set and price maintenance is carried out by a syndicate bank, so the price of the shares is only determined by the regular price determination on the first day of trading. This should always be taken into account. Well-known companies that have carried out their stock exchange listing in the form of a direct listing are, for example Spotify, Slack or Roblox.

Reverse takeover

In a reverse takeover, a company is listed indirectly. This happens when a public company is taken over by a private company. In short, a merger or takeover takes place and the two companies combine their shares and offer them to the public. The advantage of a reverse takeover also lies in the cost and time savings.

SPAC

A similar strategy to that of a reverse takeover is also pursued by listing on the stock exchange by means of a SPAC. Here, a so-called SPAC (special purpose acquisition company) raises capital by means of an IPO. A SPAC is an empty shell company that exists solely to buy up non-listed companies and thereby give them access to a stock market listing. In contrast to a reverse takeover, there is also the possibility of providing additional liquidity to the company being taken over.

Advantages and disadvantages of an IPO

As already mentioned, there are several other ways to list your own company on the stock exchange in addition to the classic IPO, so we would now like to explain the advantages and disadvantages of an IPO once again:

Advantages of an IPO

• a successful IPO gives the company the opportunity to raise large amounts of capital
• The reputation and awareness of a company increases through an IPO
• IPOs give investors the opportunity to acquire a company's shares publicly, which is much easier than in private trading
• An IPO guarantees a regulated issue price and subsequent price maintenance by a syndicate bank

Disadvantages of an IPO

• Very costly and time-consuming
• Companies listed on the stock exchange must comply with the regulations of the financial supervisory authority
• Company figures such as the balance sheet must be disclosed