Research And Definition On Initial Public Offering Finance Essay
The term “going public” or initial public offering refers to the selling of shares to the public by a company for the first time (Gitman, 2009, pg. 338). Many companies tend to go public when they see a need to obtain additional resources to finance certain activities and projects. For instance, companies consider going public in order to gain the necessary moneys needed to acquire equipment and other factors to achieve various innovative business initiatives they believe would be profitable (Stock Market Investors, 2008). Going public is considered appropriate for both startup and established companies (Entrepreneur Media, 2005). A startup company may go public to show its ability to grow into a profitable business that delivers increases in sales and earnings annually, whereas, established businesses can go public to demonstrate their abilities to achieve significant growth in the future.
As stated by Gitman (2009), there are three alternatives available for a firm which desires to sell its stocks in the primary market, namely, a public offering; a rights offering or a private placement. However, this paper will focus on public offering. It will identify the steps required for a company to become a publicly traded firm as well as the pros and cons associated with going public. It will also address the issue of whether or not businesses in the Caribbean should enter the public markets and if so, how can they accomplish this and which markets can be considered as the best option.
Steps required in becoming a Publicly Traded Firm
According to Gitman (2009) the first step to going public is to obtain the authorization or permission from its present shareholders who are considered “the owners of shares of stock in a corporation”
(http://wordnetweb.princeton.edu/perl/webwn?shareholder). As mentioned in the Introduction, going public involves a private company selling its shares to the public, therefore, it is of utmost importance that the business seeking public offering gets the approval or ‘right-of-way’ to do so since going public can reduce the level of authority held by current shareholders.
Secondly, upon receiving the shareholders’ approval, the company then has to get all their documents certified by auditors and lawyers as being legitimate. The auditors certify and make certain that for the past five years, all the company’s financial statements followed the Generally Accepted Accounting Principles (GAAP) and the lawyers deal with matters like litigation loans (Gitman, 2009; Schwartz, 2008; Irwin, n.d).
In step three the company then gets an investment bank that agrees to underwrite the offering. The underwriter is considered crucial to the success of a company’s IPO. The underwriter is responsible for providing credibility for the business to probable buyers, in particular the institutional investors. The underwriter also pulls together the correct syndicate and selling group to get the company’s stock into the hands of the best mix of shareholders. The company along with the underwriter then negotiates on the basic terms of the underwriting – estimated size of the offering, projected price per share and the fees and expenses associated with underwriting. These terms are then documented in a letter of intent which basically serves as a contract between the firm and the bank (Gitman, 2009 & Schwartz, 2008). However, until the Securities and Exchange Commission (SEC) affirms that the registration statement is effective and a formal underwriting agreement is signed, the underwriter is not required to purchase the company’s stocks.
The fourth step to going public entails the company filing a registration statement with the SEC. Part of the registration statement is referred to as a prospectus which contains information regarding what the company does, who the majority of stockholders are, and what the outlook for the company’s future looks like (Gitman, 2009, pg. 338). Once the statement is filed, it is then transformed into the preliminary prospectus or “Red Herring”. The preliminary prospectus establishes that the registration statement has been filed with the SEC but is not yet effective. After the registration statement is accepted and approved by SEC the investment community can start the analyzing process of the prospects of the firm. As stated by Gitman (2009), “from the time it files until at least one month after the IPO is complete, the company must observe a quiet period, during which there are restrictions on what company officials may say about the company.” The quiet period is intended to ensure that the same information about the company, that is, the information from the preliminary prospectus and not any unpublished information that may give them an unfair advantage, is accessible to all possible investors (Gitman, 2009, pg. 338 and 339).
Step six begins after this process is completed and the marketing of the offering commences. The company’s stock offering is then promoted by both the executives of the company and the investment bankers through a road show. This road show, as defined by Gitman (2009), is “a series of presentations to potential investors around the country and sometimes oversees”. The road show not only provide relevant information to possible investors about the new issue but it also help the investment bankers measure the demand for the offering and thus, set a price range.
Lastly, after the share price and terms are set by the underwriter and the SEC approves the offering, the formal underwriting agreement is signed. When everything is finalized the underwriter then receives the shares that have to be sold and the company finally receives the capital obtained from the offering.
The Pros and Cons of becoming a Public Firm
Acquisitions by the company may be made with publicly traded stock – If a public company anticipates growth through acquisition, and its stock has performed well in the after-market, the company may be able to preserve its cash position and make acquisitions using its own stock as payment.
A company's ability to raise additional capital is often enhanced after going public – Since the sale of stock by a corporation increases the company's net worth and decreases its debt-to-equity ratio, the company is often able to increase its borrowings and obtain terms more favorable than before the offering. Furthermore, if the company and its stock have performed well, the company can return to the market at a later time and sell additional shares to the public.
The company which has gone public will achieve a much higher degree of liquidity in comparison to private company. The common stock of a privately held corporation is generally an asset without a readily available market or an easily determinable value. A publicly traded company, however, has a ready market for its stock at quoted prices.
A public company tend to entice and retain better employees – A company may not be able to pay high salaries but by going public, uses its potential to attract and retain the best personnel by offering stock to such employees that will likely be more valuable. After the public offering, various types of employee benefit plans using the company's common stock are generally used to attract and motivate employees at different levels. “Stock options and bonuses are excellent methods for wining employees’ loyalty for the instilling of a healthy ownership attitude among them if the company’s stock performs well in the market.” (Zimmerer and Scarborough, 2005 page 394)
The founders of a company which has gone public will achieve a much higher degree of liquidity for their investment – The common stock of a privately held corporation is generally an asset without a readily available market or an easily determinable value. A publicly traded company, however, has a ready market for its stock at quoted prices. In addition to the portion of their stock that the founders may have sold as part of the original public offering, the founders will have the ability to sell additional shares for diversification or other reasons, although such sales may be subject to significant limitations.
Among the advantages of a firm going public there are many disadvantages as to why a company may choose not to go public (Lewis & Kappes, 2010). It is very costly for a firm to go public. Even though the deal does not go through the firm can loose the money that it has already spent as down payment; apart from this there is other costs associated, such as legal and accounting fees; filing fees; travel costs; printing costs and sponsor expense allowance; and also reporting requirements under the Exchange Act of 1934.
This in itself is a complicated process and if management and persons involved with the transition is not acquainted with what has to be done; like registration, it makes it even more difficult as they will have to focus on putting structures in place which will disrupt their daily business (Lewis & Kappes, 2010).
Another disadvantage of going public is that public companies are open to public scrutiny; in that companies’ information are revealed to “john public” and may not be the best thing, as some of this information may be considered confidential, and can be used by competitors. Also, information pertaining to firms that has an informal decision making process where decisions are made to their desires and not the shareholders, are also open up to the public (Lewis & Kappes, 2010)
A public firm’s personnel are limited in their ways to selling, and purchasing shares in the firm because the various laws and limitations imposed, such as 144 section 16, limit transactions in the firm’s securities (Lewis & Kappes, 2009).
Public companies are also at risk of takeover attempts but can be remedied by a staggered or as one may say, spread out board of directors.
How can Caribbean companies enter the public markets and where
Public markets are places where companies can advertise, promote or sell their stocks on both the regional and international scene. Caribbean companies have never been exempted from public markets and as a result they can enter these markets to conduct trading and create a market for their stocks and aid as a means of opportunity for both the companies and its investors. However, the question is how can they enter these public markets and where will be must appropriate?
Many Caribbean companies have been able to go public, trading under the Eastern Caribbean Security Exchange (ECSE). Today, there are eight (8) countries under the Organization of the Eastern Caribbean States (OECS) trading under the ECSE market namely, Anguilla, Antigua and Barbuda, Dominica, Grenada, Montserrat, St. Kitts & Nevis, St. Lucia and St. Vincent and the Grenadines all are Caribbean countries with Caribbean companies trading on these public markets http://www.ecseonline.com/oecs_pub_co.php .
In Grenada there are many companies that have been able to enter the public markets namely, Grenada Cooperative Bank, Grenada Breweries Ltd., Republic Bank Grenada Ltd., Grenada Electricity Services Ltd., and Jonas Browne & Hubbard Ltd. All these companies have been able to trade their products or stocks on the international scene. http://www.ecseonline.com/oecs_pub_co.php
As with any company entering public markets is an important aspect of going public within any firm, the prominent area of focus will be to involve all individuals of the organization most importantly your shareholders, who will be the main decision makers. Other areas that will be beneficial to the firm would be to adapt various principles which involve maintaining a high level of consistency, transparency and accountability; thereby the general public, including investors would be able to adopt a sense of trustworthiness to the organization. There are a list requirements needed on how to go public:
- For companies to go public their products or services being offered should be able to meet auditing requirements. In addition, the company itself must be competitive and continually establishing high growth. Once these distinctive traits are achieved a proposal from the management team must be given to the Board of Directors. It will indicate or put forward the need to be listed on the public market. This prospectus will depict objectives, performance and financial projections of the organization (Schwartz, 2008). However, a company must be listed on the ECSE in order for their securities to be traded on the public market. This will in turn satisfy the listing requirement of the exchange approved by the Eastern Caribbean Securities Regulatory Commission (ECSRC). The requirements for being listed on the ECSE are as follows:
1) Satisfying the listing requirement
2) Sharing ownership
3) Meeting disclosure and registration requirements
However there are specific requirements on the ECSE, they include:
1) Fees & dues
2) Legal requirements
3) Listing application requirements
4) Disclosure & reporting
- Another way in which Caribbean companies can go public is the Initial Public Offering (IPO); however this applies to private companies who want to go public. Once they are public it will require servicing their investors, the Securities and Exchange Commission (SEC) and other parties that are interested. For these private companies to go public, firstly they will have to pay a fee of Five Hundred Thousand Dollars ($500,000) which would have to be paid per year for accounting purposes and director liability insurance fees.
In addition to how Caribbean companies can go public the other issue is where would be must appropriate for companies to go public. In the earlier parts we mentioned the ECSE, which is on the regional scale connected to the Eastern Caribbean Central Bank (ECCB). This organization focuses on the trading of corporate stocks, government securities and bonds, including other financial products. They basically provide a primary and secondary market for companies to trade securities.
On the international scale we have the LSE, NYSE and NASDAQ just to name a few. Firstly, The London Stock Exchange (LSE) requires that at least three (3) years availability of accounting processes should be made available. The estimated market value of the company’s securities which are to be listed on the London Stock Exchange (LSE) should be at least: £700,000 for shares and £200,000 for debt securities. http://www.londonstockexchange.com/about-the-exchange/company-overview/company-overview.htm
Secondly, with Nasdaq it is noted that for companies to trade on Nasdaq they need to have at least 1.1 million publicly-traded shares on listing, apart from those held by other individuals within the organization such as, beneficial owners, directors and officers of more then 10 per cent of the company. It is also noted that the least amount on the bid price of a stock on list should be a minimum of $5. There are also Corporate Governance rules that are needed to be followed under Nasdaq. In addition, the company or organization should have a minimum of 400 shareholders to list on Nasdaq. To Nasdaq shareholders must possess over 100 shares. http://www.altiusdirectory.com/Finance/listing-requirements-nasdaq.html
To be listed on the New York Stock Exchange, a company is expected to meet certain qualifications and to be willing to keep the investing public informed on the progress of its affairs. The company must be a going concern, or be the successor to a going concern. In determining eligibility for listing, particular attention is given to such qualifications as: 1) the degree of national interest in the company; 2) its relative position and stability in the industry; and 3) whether it is engaged in an expanding industry, with prospects of at least maintaining its relative position. While each case is decided on its own merits, the NYSE generally requires the following as a minimum:
- Earning power under competitive conditions of: either $2.5 million before Federal income taxes for the most recent year and $2 million pre-tax for each of the preceding two years,
- Front line aggregate for the last three fiscal years of $6.5 million together with a minimum in the most recent fiscal year of $4.5 million. (All three years must be profitable.)
- The NYSE will consider each company on a case by case basis. Net tangible assets of $40 million, but greater emphasis are placed on the aggregate market value of the common stock. Market value of publicly held shares, subject to adjustment depending on market conditions
When a firm goes public it will be beneficial to both the business and the investors, including the general public. Once firms are able to sell their stocks on an international scale it helps to gain exposure for the firm and allows them to achieve great benefits. However there are many requirements involved in firms going public but the end result will be must valuable.
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