May 29, 2020
Investing Fundamentals For Young Adults: Understanding Risk
By taking the time to understand the full scope of the potential risks and rewards of an...
February 06, 2020
This is part 1 of a two-part blog series on Initial Public Offerings (IPOs).
In 2019, 149 companies priced IPOs, raising $46.3 billion, the largest being Uber ($8 billion). The record year was 2014, with over $80 billion in deals priced, of which the Chinese internet giant Alibaba ($25 billion) included in the total and largest on record. Visa is the second largest on record at $19 billion.*
Founders of privately-held startup companies typically raise capital by issuing preferred stock to venture capitalists (“VCs”) with pre-negotiated equity stakes. Multiple rounds of financings follow as the company grows over time, via issuance of additional preferred stock and/ or customized debt borrowings. When the company decides it is time to “go public”, the IPO will create new, publicly-traded (Class-C) common shares, the proceeds will then typically payoff all outstanding preferred shares (and/or debt) of the original stakeholders, enriching their wealth.
Anticipation and excitement precede an IPO pricing. In some cases, the share price can spike higher when the new common shares are free to trade. A watershed moment in the company’s history, original founders often celebrate the moment together by ringing the closing bell on the New York Stock exchange.
Before the celebration begins, investment bankers will have pre-negotiated the number of shares the company will issue and an offering price. The actual offering price is determined by the company valuation divided by the number of shares issued. Attention is focused on making sure there is an ample supply of the new common shares available to the public (known as “free float”) to maintain reasonable share-price stability. More recently, many VCs have pre-negotiated that their initial investment (or some multiple) be fully repaid before any of the new common shares can trade. In the case of Uber, large pre-IPO investors were guaranteed to receive the $42/share initial pricing level, which ultimately depressed the share price in the open market. By comparison, Beyond Meat, which produces a vegetarian-based meat substitute product, priced its IPO in April at $25/share, which then spiked to over $75/share on the first day of public trading.*
In next week’s Part 2 discussion, we’ll address the estate planning challenges for founders and significant employees from IPOs.
Brad Craig is a senior relationship manager in CIBC Private Wealth Management’s San Francisco office with more than 40 years of industry experience. In his current role, he consults with clients and their advisors to develop and implement customized investment allocation strategies.
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