Foundations of New Venture Finance 295The Initial Public Offering (IPO) Process
A public offering in the United States takes six to nine months to plan and execute.
Administrative costs, printing, and legal fees may run from $500,000 to $1,000,000. The under-
writers typically receive fees of 7.5 percent of the total proceeds as well as options to purchase
additional stock at reduced prices.
The underwriter(s) are the investment bankers and brokerage houses that sell the stock to the
public, generally through their retail distribution network. There are three types of selling efforts:
best effort, best effort (all or none), and firm commitment. In the simple best-effort case, the
underwriter agrees to sell as much as possible of the stock that is authorized, and the public issue
goes into effect even if not all the authorized stock is sold. The best-effort scenario occurs when
the company is relatively small, the investment banker is regional, and the company’s prospects
are somewhat in doubt.
The best-effort (all or nothing) scenario requires the investment banker to sell all of the
authorized issue or cancel the offering. This means that the company will not go public unless it
can sell all its stock and raise all the money it needs for financing its future. The advantage here
is that the firm will not become public and undercapitalized. The disadvantage is that fees and
costs associated with this strategy are not recovered if the offering is canceled.
The firm-commitment selling effort is the safest and most prestigious for the new venture’s
IPO. The underwriters guarantee that the entire issue will be sold by buying most of it them-
selves and reselling it to their customers. This is done for companies with the most solid back-
grounds, products, and management. The underwriters share some of the risk of the offering by
purchasing shares for their own accounts.
The process of going public begins long before the shares are actually sold. The preliminary
stages require the venture to meet the criteria of a public firm: a demonstrated record of growth
in sales and earnings, a record of raising capital from other outside investors, a product that is
visible in the market and of interest to investors, audited financial statements, clear title to the
technology, an estimable board of directors, and a management team sufficiently seasoned to
simultaneously run the company and manage the IPO process.
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If these criteria are met and the venture’s managers have determined that the next step is a
public offering, the process can formally begin. At this point, management will solicit proposals
from underwriters for the IPO. Underwriters will respond with their philosophy, strategy, and
tactics—as well as with the estimated costs of their services. Management must then select among
the proposals and may suggest joint and cooperative efforts if that seems reasonable. Once the
underwriter is hired, the offering begins.
- Organization Conference:This is the first meeting that brings together the three major
parties to the IPO process: management, the underwriter, and the independent accounting
firm that will prepare the financial statements. All parties bring their lawyers. They discuss
the timing of the IPO, the nature of the offering in terms of amounts to be raised, the sell-
ing strategy, and the allocation of tasks. The lawyers inform all parties, but especially man-
agement, of the current legal constraints on trading and disclosure.
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