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How an IPO gets done, step by step

how to price an ipo

Edgar Su | Reuters

Alibaba founder Jack Ma gives a thumbs-up as he arrives to speak to investors at an initial public offering road show in Singapore Sept. 16, 2014.

Alibaba's long-awaited IPO is finally around the corner, making this a good time to take a look at just how an IPO works.

In an initial public offering (IPO ) a company issues stock to the public for the first time. Why would a company want to go public in the first place?

  1. To raise money to grow the company. This is the most common stated reason.
  2. For liquidity. The company may have private equity investors who want to exit from their investment. It may have senior management that may be retiring or seeking to monetize their investment. It may want to reward employees with options.
  3. Balance sheet restructuring, i.e. they are raising money to pay down debt.
  4. Acquisitions: They need money to buy other companies.
  5. Talent recruitment: Going public gives a company a "currency" it can use to recruit talent.

What's next? The easiest way to visualize this is using a timeline.

Roughly six months before the IPO

The first step is a "beauty contest": You show off the company to bankers! The banker writes the legal documents and shepherds the company through the IPO process. The banker

will "underwrite" the deal—that is, they will buy up all the initial shares and then sell them to the public at a predetermined price.

Which banker (or bankers) to go to? That depends.

Some companies already have close relationships to companies like Morgan Stanley. Credit Suisse ,Goldman Sachs. or others. One consideration is whether the bankers have an expertise in the space you are working in, such as biotech.

Another consideration is distribution. Most companies want as many investors as possible to own stock in the company. Some banks have broader distribution networks than others. Some have expertise in distributing stocks to institutions.

Big firms may seem like obvious choices, but smaller regional or investment boutiques may have relationships with very specific investors that may be a better fit.

One thing's for sure: A company with a strong business will have many bankers competing for their very lucrative deal.

How lucrative? For a small IPO (about $100 million) it could be as high as 6 to 7 percent of the float. Generally the bigger the IPO, the smaller the fee, so a bigger, higher quality IPO would typically get charged 3 to 5 percent.

Alibaba is so big—the IPO is likely to raise more than $20 billion—that they likely got a substantial discount, charging something around 1 percent.

But even 1 percent is $200 million in fees!

Category: Forex

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