Initial public offerings: listing your company explained

Going public through an Initial Public Offering (IPO) is a significant milestone for any business.

In the world of finance, few events generate as much buzz and excitement as an IPO. (Psst…not to be confused with the other IPO: intellectual property office!)

Obtaining an IPO is a pivotal achievement for businesses, marking their transition from a private entity to a publicly traded one. But, what exactly is an IPO? Why do businesses go public? And how does it all work? 

In this article, we’ll explore the ins and outs of IPOs, answering questions like what they are, why businesses pursue them, how they work, and what the associated benefits and risks are.

What is an IPO?

As a small business owner, the path to an IPO represents the pinnacle of your ambitions. It’s a ticket to the big leagues and a true cause for celebration.

But, it’s not just about prestige and financial clout. Going public transcends these dimensions. It’s an opportunity to share your success with your employees, granting them the chance to become stakeholders in the very enterprise they’ve helped nurture.

As a small business owner, the IPO path is the journey of a lifetime, marked by rigorous preparation and determination.

How do IPOs work?

To start the process, a company typically hires an investment bank to underwrite the offering. 

Underwriting means the bank agrees to purchase the shares directly from the company and then sell them to investors. 

This arrangement ensures that the company receives the capital it needs to grow while allowing the bank to profit from the spread between the purchase and sale prices.

Benefits of going public

• Access to capital: one of the primary reasons companies go public is to raise significant capital. These funds can be used for various purposes, such as expanding operations, developing new products, or paying down debt.
• Liquidity for shareholders: going public provides existing shareholders with an opportunity to sell their shares on the open market. This provides liquidity they might not have had as private investors.
• Access to institutional investors: public companies can attract institutional investors like mutual funds and pension funds, which can lead to increased demand for their shares.
• Brand awareness: public companies often enjoy higher visibility, which can enhance their reputation and brand recognition.

Risks of going public

• Increased regulatory oversight: public companies must adhere to stringent reporting and regulatory requirements, which can be costly and time-consuming.
• Loss of control: as more shares are sold to the public, the company’s original founders and management team may lose a significant proportion of control over decision-making.
• Market volatility: public companies are subject to market fluctuations, which can impact their stock prices and shareholder sentiment.

What determines the share price?

The share price in an Initial Public Offering (IPO) is a dynamic reflection of market sentiment and investor appetite. 

Needless to say, this isn’t a number plucked out of thin air. Instead, it’s the result of a fascinating interplay between supply, demand, and financial valuations.

At the heart of this process are the forces of supply and demand. Investors, both institutional and individual, express their interest in owning a piece of the company by placing bids for its shares. These bids indicate the price they are willing to pay for a share.

The company, with the guidance of its underwriters (typically investment banks), gauges these bids and assesses the overall demand. This forms the basis for setting the IPO share price. Essentially, it’s a negotiation between the company and the investors, with the market serving as the ultimate arbitrator.

The price discovery phase

The IPO process often involves a “price discovery” phase. During this period, the company, underwriters, and potential investors engage in a series of discussions and assessments to pinpoint the optimal share price. 

This dialogue allows the company to gauge investor interest and market conditions, ensuring that the price aligns with the perceived value of the company.

Once the final IPO share price is determined, investors who successfully acquire shares pay that price. The company then receives the funds raised from these share sales, minus the fees charged by the investment bank for facilitating the offering.

These fees cover a range of services provided by the investment bank, including market research, legal compliance, and marketing the IPO to potential investors. They are an integral part of the IPO process, and their deduction is factored into the overall financial planning of the company.

While the share price is a critical component of an IPO, it goes beyond mere financial calculations. It’s a reflection of investor confidence, the company’s growth prospects, and the perceived value of its products or services. It’s a manifestation of the belief that this company, now entering the public arena, has a promising future.

When do businesses list on the stock exchange?

Most businesses typically list on the stock exchange at different stages in their development, which can vary widely based on factors such as industry, growth trajectory, and funding needs. However, here is a general overview of the stages at which businesses commonly consider going public:

Startup phase (0-5 years)

Many businesses start as small startups with limited capital. During this phase, they focus on product development, market validation, and initial growth. Going public is usually not a priority at this stage, as they are still building their foundation.

Early growth phase (5-10 years)

After gaining some traction and securing additional funding, businesses may enter the early growth phase. They focus on scaling operations, expanding their customer base, and increasing revenue. Some businesses might consider going public during this stage to access more significant capital for expansion.

Mature phase (10+ years)

Businesses that have established themselves in the market and have a proven track record of profitability often consider an IPO during this phase. Going public can provide access to a broader investor base and a means to raise substantial capital for further expansion or debt reduction.

Different types of IPOs

There are several types of IPOs, each with its unique characteristics:

• Fixed price IPO: in this type, the company sets a fixed price for its shares before the offering begins. It’s the most common type of IPO.
• Book-building IPO: here, the investment bank collects bids from investors before setting the share price. This method is more common for larger companies.
• Direct listing: in a direct listing, the company bypasses the involvement of an investment bank and lists its shares directly on the stock exchange, allowing investors to purchase them directly.
• Reverse merger: a private company merges with a public shell company in a reverse merger, allowing it to go public without the traditional IPO process.

The choice of IPO type depends on factors such as company size, capital requirements, and investor interest. Fixed price IPOs offer stability, while book-building IPOs provide flexibility.

Preparing to list your business

Before going public, a company must undergo extensive preparation. 

This includes filing a registration statement with the Securities and Exchange Commission (SEC), conducting due diligence, and marketing the offering to potential investors. 

Additionally, companies must comply with various regulations governing public companies.

IPO eligibility criteria

To be eligible for an IPO, a company must meet certain criteria, including demonstrating a track record of profitability, having a strong management team, and outlining a clear growth strategy. 

Transparency is crucial, as companies must be willing to disclose substantial information to potential investors.

Listing on AIM vs Standard List (Main Market)

When it comes to taking a business public, the United Kingdom offers two distinct choices: the Alternative Investment Market (AIM) and the Standard List, also known as the Main Market. 

These two options provide businesses with avenues to raise capital from public investors, but they differ significantly in their accessibility, regulatory requirements, and suitability for companies at various stages of development.

Listing on AIM

AIM, established in 1995, was specifically designed with smaller and growing businesses in mind. Often referred to as the “junior market,” AIM offers a more accessible entry point for companies seeking public investment. 

Small businesses, startups, and those with growth potential find AIM attractive due to its less stringent requirements compared to the Main Market. 

AIM operates under a flexible regulatory framework, subjecting companies to the AIM Rules for Companies, which are generally less burdensome and offer more relaxed reporting and governance standards than the Main Market’s Listing Rules. This makes listing on AIM a cost-effective option, especially beneficial for small businesses with limited financial resources. 

The market also attracts growth-oriented investors, aligning with the aspirations of many smaller companies that require capital for expansion, research and development, or market penetration. 

AIM further provides access to both institutional and retail investors, offering a broader pool of potential backers for small businesses.

Listing on the main market (standard list)

In contrast, the Main Market, or Standard List, serves as the flagship market of the London Stock Exchange and imposes stricter listing requirements. 

Companies opting for the Main Market must meet higher thresholds for market capitalisation, financial performance, and corporate governance. Typically, businesses that choose this route possess a longer track record of profitability and stability, making them more established entities with a history of consistent finances. Such companies must also adhere to the comprehensive Listing Rules, which demand a higher level of regulatory compliance and transparency. 

While the Main Market provides access to a larger pool of institutional investors, it may be less appealing to smaller businesses seeking retail investor support.

Which should you choose?

The decision to list on AIM or the Main Market hinges on a company’s size, stage of development, and growth ambitions. 

For small business owners and startups, AIM’s accessibility and flexibility make it an appealing option. AIM offers a cost-effective and less demanding pathway to access public capital markets, enabling businesses to take their initial steps towards going public. 

As these companies mature and grow, they may opt to transition to the Main Market when they meet the stricter criteria and possess the necessary resources to navigate its more rigorous regulations. 

Conclusion

In summary, IPOs offer businesses a significant opportunity to raise capital, increase visibility, and achieve growth. However, they are complex and costly endeavours, and not all businesses qualify. 

If you’re considering taking your company public, it’s essential to consult with an investment banker or securities lawyer to navigate the process successfully.

But dare to dream, small business owner. See your company not just as it is today, but as the towering skyscraper it has the potential to become. 

An IPO is not merely a financial event; it’s the chapter where your aspirations come to life—a journey from the shadows to the limelight, from modesty to prestige. It’s your time to shine, inspire, and build a legacy.