🤷♀️ What even happens during an IPO, anyway?
San Francisco native (yes, really). @uw and Lowell High alum. I like to nerd out on fintech, stock options and taxes.
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San Francisco native (yes, really). @uw and Lowell High alum. I like to nerd out on fintech, stock options and taxes.
Vieje back here with a pre-Labor Day Weekend newsletter. It’s been a fun summer back in New York, but I for one am ready for some cooler temperatures, football, and time at home. I’m also excited for the IPO window that’s slated to open this fall.
As we head into the fall, many companies have recently filed S1s marking an intent to have an Initial Public Offering (IPO). Via, Figure, and Netskope have released their public S1s. There are a handful of other tech companies that have also filed confidentially or will soon file. September is slated to be a busy month of IPOs, and this is the moment many of us in the tech world have been waiting for.
As we head into the IPO window, I thought it would be great to revisit a topic we’ve previously covered – what actually happens during the IPO process. Whether your company is in the process of going public or aspires to be public one day, this will be a great refresher so you have an understanding of what happens behind the scenes.
An initial public offering (or IPO) is the debut of a company on the big stage of the public stock market. It's like opening the doors of a theater for the public to buy tickets. Up until that moment, only a select few, like the backstage crew and VIPs, had access. But now, regular folks can become part-owners of the company by buying shares on public stock exchanges, sharing in the excitement and potential profits.
This also means that as employees, you will have the opportunity to sell your hard-earned equity in the public markets and often, realize the value of your shares for the first time.
The first step to going public is to have alignment between buyers (the market investors) and sellers (the company). To state the obvious, no company wants to go public and have it fall flat. But, before I talk about timing, let me give an overview of the nuts and bolts of the process.
First, a company files an S-1 form. This is an SEC registration form that is a requirement for any company that wants to IPO. For all intents and purposes, the S-1 includes all details about the company: finances, management, future business plans, potential risks, and more. It’s essentially a window into the company for any prospective investors. That said, it’s not necessarily exhaustive, but it is the first window for many into the company’s operations. The S1 will typically be filed “confidentially,” meaning the public cannot access it. Eventually, the S1 will flip “public,” meaning that anyone can go on the SEC website and view it.
Next, the company, along with investment bankers, meets with potential investors. You may have heard the term “roadshow” thrown around. Not totally unlike a VC funding round, a company’s executive team will start meeting with, or presenting to, investors. Basically, they’re pitching the IPO and getting indications of investor demand and at what price point, so they can price it. This isn't an exact science – it's a mix of market trends, company performance, and investor appetite.
Finally, investors in the IPO receive an “allocation” of stock at the IPO price. Then the stock is listed on the exchange and can begin trading hands between those who have stock and those who want stock. The price moves around to balance supply and demand. Oftentimes, newly IPO’d stock “pops” on the first day of trading. In fact, the average first-day return from the IPO price has been ~19% historically. That doesn’t mean all IPOs go up; there’s a wide range of potential outcomes, but on average, IPOs are underpriced relative to where they end their first trading day.
Theories about why IPOs are underpriced abound. Some people think underpricing attracts attention, so it’s a form of marketing. Others say it’s compensation to the underwriters for taking risk. Still others claim it's a loose conspiracy to extract value from the selling shareholders. Regardless of the reason, the fact remains, most stocks rise on their first day of trading.
Companies also try to price appropriately because many actually don’t want too big of an IPO pop. The reason being that if the price settles over time, they don’t want it to look like a big fall or a crash. So, they want to set a price that looks appropriate and has room to move (hopefully up) rather than down.
This is obviously a simplified version but at its most basic, this is what happens when a company decides to IPO.
Short answer: no. You’ve probably read about a number of companies that have filed an S-1 recently. Filing one is just the first step in the process. They do “expire” after a certain amount of time, so many companies will keep re-upping it to keep it up-to-date. Doing so does require time and expense, though, so some companies may opt not to refile if they decide to delay for a while.
This is one reason why, as an employee, the process can seem so murky. There’s no predetermined timetable for this. Many companies are understandably hesitant to share too much information with employees until things are set in stone. As an employee, this can feel unnerving. But it’s also why we believe it’s important to figure out your equity as early as you can. Hopefully, you’ll have some knowledge that your company is preparing for an IPO, but oftentimes it’s not actually happening until it is, and the first you may hear is your company telling you that it is.
As I alluded to earlier, there is most definitely a timing aspect to going public. Much of it depends on the market environment. Buyers (investors) and sellers (the company) need to have alignment that an IPO makes sense and that the price is right. One reason we believe the drought has continued, despite stabilization in the stock markets, is due because buyers and sellers were so far apart on price.
Once the bear market hit, there was a lack of demand, aka buyers. Investors became more risk-averse and were much less likely to buy into a new company hitting the market. But that has shifted somewhat. While the bull market has returned, the valuations of 2021 haven’t. And many companies — and their founders — have been unwilling to accept that hard truth.
The flip side of that coin is, again, no company wants to flop on the public market. Even if they’ve already bitten the bullet on a lower valuation, companies want to go when the timing is right. In a down market, of course nobody wants to go. But even as the market has stabilized, many are still waiting for that “right moment.” Look, in my opinion, timing does matter, but it can also be a futile exercise. Just like you, as an individual, could have bought a stock at a lower price or sold it for a higher price in retrospect, the “perfect” timing is elusive. But investors are hungry for IPOs, and we expect this window to open in September.
Again, you likely have an idea if your company is close to an IPO, but you may not know definitely until you get a memo from your company that they are actually IPOing.
Still, employees have an exciting role to play, like the dedicated cast and crew members of a movie production. You’ve spent years putting together a production, and it’s finally time for public consumption. But for those who worked on it, you’ll also be under embargo for a period of time, where you can’t spill any of the plot secrets. This is known as the lockup period, where employees are unable to sell their shares immediately following an IPO.
Typically, a lockup period lasts around six months from the date of the initial listing, but it can vary. When your company shares all the information about your IPO, details about the lockup period should be included. Sometimes, they open the window sooner, either for a limited period and/or to sell a limited amount of shares. For example, they may let you know that, although the lockup period still remains, you have a certain amount of time (i.e., two weeks) to sell up to 25% of your holdings.
As your company gears up for an IPO, I believe it’s vitally important that you create a plan for stock options and equity. There are large tax consequences that could potentially be minimized by exercising your stock options prior to the company going public. Making a plan could mean a large difference in what you ultimately take home from your hard-earned equity.
It’s an exciting time, for sure, but it can also feel like you’re a chicken running around with your head cut off because once that train leaves the station, you’re on the move. And oftentimes, employees haven’t even thought about their equity, let alone created a plan for it, until an IPO has become a reality. While it may feel like a problem, all things considered, it’s a good problem to have.
It’s hard to remove emotion from this — both the highs and the lows — so it certainly helps to work with somebody who understands this stuff but can also bring an objective perspective while considering your personal situation. If you are looking for help, feel free to reply, and we can set you up with one of our specialists.