I know its a very basic question but it just makes me wonder why cant companies perfrom their own IPO and have to go through Investment Banks
one reason i can make out is that it requires a hell lot of legal compliances and even the penalties of non compliance with them are quite large. also at many places its mandatory to have ur issue underwrittern and u also need a stablising agent for which u would require a merchant banker in any case
It’s the underwriting risk i.e. whichever bank is helping with the ipo, will also have to market make the stock i.e. be the book runner for the first few days. This involves a very significant amount of risk - one, which non-financial companies are typically not capable of handeling (either due to lack of expertise or capital required). On top of it, they don’t have the depth of access to institutional investors, which investment bankers do, in order to build a pre-ipo book and determine the offer price.
Simply put - if your model says the firm is valued at $25 a share - the investment bank’s syndicates and sales staff go around doing roadshows, talking to institutional investors and other counterparties to gauge their interest, see where they’d be bidding/offering (i.e build a book).
Whilst investment banks have their legal department, it is mainly there to defend the instituion against claims - when assisting in an ipo, investment banks hire legal firms like Allen & Overy etc to assist with the legal side of things and ib’s concentrate on modelling, valuations, book running, roadshows and finally market making as a PMM for a pre-specified period of time, after which they hand it off to the regular market makers.
Classic example - Facebook. Due to technical glitches at NASDAQ, facebook market makers lost circa 100 mil! That’s a tail event which is every investment bankers nightmare. Imagine putting in all those hours and sacrificing weekends and then finding out there’s no payday at the end of it.
thats pretty insightfull…but a wholesale broker can do the same exact job,cant he??
No - here in europe brokers get fined if they’re found to be trading without a client buy/sell order. Could be different across the pond or in the far east, but I highly doubt it.
ok but thats because of legal issues…what i mean is that wholesale brokers are competent enough to do the same job
^Haha - no way.
Presumably technology will make this increasingly possible in the future (to the extent that investment banks don’t arrange legislation to protect their privileged status).
For now, it’s a complicated enough process with respect to legal/regulatory requirements and liquidity management that it simply makes sense to pay someone to handle all these transaction costs in something that isn’t a business’ core competency. Really the only moment when an investment bank genuinely acts like a traditional bank is when it hands over a large chunk of cash in exchange for the company’s shares, so that the company doesn’t have to go around and find a two or three hundred thousand separate owners willing to buy a share at $17.22.
There are also conflict-of-interest issues that reduce liability by having a third party manage the due diligence and publication of announcements. Your liability for fraud goes down since mistakes can be reframed as communication errors if they go through a third party. If you do it yourself, it looks more like fraud even if it’s just a mistake.
Finally, most companies issue stock infrequently. Indeed, assuming that the company hasn’t been taken private in something like an LBO, an IPO suggests that the company has 0 experience in floating public stock, marketing it, and pricing it. There are enough things that could go wrong and are costly enough as mistakes that it just makes sense to do it with people who do these things constantly, rather than once every 5 years or so. Even with big fees, the costs are likely less than the price of making a boneheaded mistake because you are doing something outside of your core competency.
Again, technology may make self-IPOs more feasible in the future, though investment banks will undoubtedly call their congressmen and send them lots of cash to throw up barriers
A test of that would be whether investment banks like Goldman manage their own IPOs or let their competitors do it. I forget how Goldman did it. I think they did their own (EDIT: yes, they did, so it is not illegal to do your own IPO, at least here in the States).
Reverse merger is a comparatively cheap alternative to IPO if the company just wants to be public and has no immmediate need/desire for new capital. I have a lot of clients who have gone the reverse merger route.
Lots of good info, thanks for sharing guys.
@Bchad-Thanks for your always helpful advice
You might be interested in OpenIPO. It has been used in about 20 IPOs, most notably Google’s. Based on the wikipedia page, I think an investment bank is still involved in the process. It hasn’t really caught on, but I think it’s a solid idea.
They can if said companies are investment banks which are filing to become public themselves - for instance, Moelis was a participating underwriter in its own recent IPO. Incepetion level $hit brah.
They can’t be the sole lead underwriter for themselves however - there are security regulations against this I think, just like auditors don’t audit their own finanicals. The lead underwriter must do extensive due diligence on the IPO target, and even though they are engaged and act as an agent of their client to promote the issue, they have a duty not to defraud the general public. Too many obvious conflicts of intetest.
Speaking of Google, they didn’t exactly have a great IPO. I don’t know many companies that would really want to be notable for their IPO.
https://hbr.org/2010/05/how-i-did-it-googles-ceo-on-the-enduring-lessons-of-a-quirky-ipo
-An interesting article, (from the CEO, so clearly biased). Overall they wanted to avoid the IPO pop, but it happened anyway. It seems like the only positive they could really take away from the process was that they were able to do it their way (which doesn’t seem like great reason not to use an investment bank)