IPO Basics: Investment Bankers, Underwriters, and Other Key Players

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link: http://www.inc.com/articles/1999/11/15746.html

The Beauty Contest - Investment Bankers

Despite its moniker, the beauty contest should not be taken lightly. During this pageant, several teams of investment bankers will parade before a company's board of directors touting their particular strengths. The company and its bankers will likely discuss the following topics:

    * Experience. The company should inquire about the underwriters' experience in the company's industry. Have the underwriters managed the initial public offerings of other companies in the industry? How have these IPOs performed?
    * Preliminary valuation. Based on the company's financials, the underwriters will prepare a preliminary valuation of the company. The underwriters will also factor in the assumed growth rate of the company and industry, as well as the multiples (or price/earnings ratio) assigned to comparable publicly traded companies.
    * Logistics. What are the strengths and weaknesses of the underwriters? Research? Marketing? Which research analysts will be assigned to cover the company? What are the reputations of these analysts? Have the underwriters worked together before?

After the presentations, the company will reward the winning contestants with an opportunity to manage the IPO. If the company selects more than one investment bank, one will be designated as the lead underwriter while the others will be comanagers.

Underwriters

The managing underwriters may underwrite the IPO on either a firm commitment or best efforts basis. In a firm commitment offering, the underwriters will purchase the shares at a discount (of usually 7%) and resell them for the full public offering price to institutional and individual investors. In contrast, a best efforts offering means that the underwriters are only committing their best efforts to sell the shares.

Most reputable investment banks will underwrite an IPO on a firm commitment basis. If an IPO is being underwritten on a best efforts basis, it should serve as a warning signal to both the company and its potential investors. After all, how enticing will a company's shares appear if its investment bank is unwilling to shoulder the risk of holding the shares, especially when purchased at a discount? Some sample underwriter discounts are listed below.
Company
Delicious Brands Inc.
Akamai Technologies Inc.
Ariba Inc.
AskJeeves Inc.
Insweb Corp.
Phone.com Inc.
Webvan Group
Goldman Sachs Group
United Parcel Service Inc.         Discount
10.0%
7.0%
7.0%
7.0%
7.0%
7.0%
6.0%
4.3%
3.5%

To help distribute the shares, the managing underwriters may form a syndicate composed of other investment banks. This serves two purposes. First, the underwriters may expand the marketing of the company's shares through other investment banks. Second, the managing underwriters may reduce their risks by allocating shares to other investment banks. The syndicate members may agree to participate by either purchasing and reselling the shares, or just marketing the shares to their institutional and individual clients.

Other Players

Besides the underwriters, a number of other key players will assist in the IPO process. This group includes the legal counsel, the auditors, the printer, the transfer agent, and the bank note company.

Lawyers

The company and the underwriters will each be represented by legal counsel. Internally, company counsel will review the company's documents, records, and business to identify potential legal problems and make required disclosures on the prospectus.

    Example - Goldman Sachs Registration Statement

    Legal Matters

              We are involved in a number of judicial, regulatory, and arbitrationproceedings (including those described below) concerning matters arising in connection with the conduct of our businesses. We believe, based on currently available information, that the results of such proceedings, in the aggregate, will not have a material adverse effect on our financial condition, but might be material to our operating results for any particular period, depending, in part, upon the operating results for such period.

    Underwriters Antitrust Litigation

              GS&Co. is one of numerous financial service companies that have been named as defendants in certain purported class actions brought in New York federal court by purchasers of securities in public offerings, who claim that the defendants engaged in conspiracies in violation of federal antitrust laws in connection with these offerings. The plaintiffs in each instance seek treble damages as well as injunctive relief. One of the actions, which was commenced in August 1998, alleges that the defendants have conspired to discourage or restrict the resale of securities for a period after the offerings, including by imposing "penalty bids." Defendants moved to dismiss the complaint in November 1998. The plaintiffs amended their complaint in February 1999, modifying their claims in various ways, including limiting the proposed class to retail purchasers of public offerings. Several other actions, commenced in November and December 1998, allege that the defendants, many of whom are also named in the other action discussed above, have conspired to fix at 7% the discount that underwriting syndicates receive from issuers of shares in certain offerings.

Company counsel will also coordinate the drafting of the registration statement, guide it through the SEC review process, help negotiate the underwriting agreement, and coordinate with the other participants.

Externally, legal counsel for the underwriters will represent them in the registration statement drafting and due diligence process, as well as in the preparation of the underwriting agreement. They will also coordinate document reviews with the National Association of Securities Dealers (NASD) and any state securities authorities.

Auditors

The company auditors will help the chief financial officer address accounting issues and prepare the financial disclosures required in the prospectus. They will also address accounting issues raised by the SEC and prepare the conform letters, which summarize their verification procedures for certain financial information in the prospectus. The underwriters receive these letters when the offering becomes effective and again at closing.

To coordinate the offering, company counsel, the underwriters, the underwriters' legal counsel, and the auditors will hold an all-hands meeting early on. At this session, the underwriters will assign the tasks for which each participant is reponsible and distribute a schedule outlining when these tasks must be completed.

Printers

Finally, the financial printer will print the prospectus, the transfer agent will issue and transfer the company's shares and coordinate shareholder mailings, and the bank note company will design and print the new stock certificates.

Copyright 1999 Findlaw Inc.

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