by Nicole Lee Comments (64)

The Initial Public Offering (IPO) Process

The Initial Public Offering (IPO) Process
Photo by Supiter5

A long time ago, initial public offerings (aka IPOs) were the end game for many technology start-ups: you could go public, get acquired, or die a spectacular death.

Or just muddle along and die a slower, more painful death.

And then one company came along and changed all that.

While everyone has been obsessing over Facebook’s IPO today, the great irony is that Facebook itself has made IPOs less relevant than ever before.

Here’s how the IPO process normally works when you’re at a bank, and what Facebook did to upend most of that – and make thousands of people very wealthy in the process:

What is an Initial Public Offering (IPO)?

It’s the first time that a previously private company can sell its shares to “the general public” (mostly institutional investors at first).

Usually the company issues around 20-30% of its shares (free float), though this varies by industry, company stage, and so on.

Most investors consider it riskier if the company only makes available a low number of shares – but if the company is “hot” enough (see: Facebook, with its 11% offering) they’ll overlook this and dive in head-over-heels anyway.

Why Do An IPO Anyway?

You probably associate IPOs with tech, healthcare, or biotech start-ups, but they apply to a much wider range of companies than that.

You see everything from mature business service companies to energy firms to transportation firms going public, but they get far less attention than hot tech start-ups (see Renaissance Capital for updated lists).

Most companies go public to:

  • Raise capital for expansion efforts or to pay back debt.
  • Provide an exit for existing investors – whether the company is PE-owned, VC-backed, or owned by a small group of individuals or a single person.
  • Get an acquisition currencymost private companies’ stock is not highly valued, so it is much easier to acquire other companies using stock once they’re public. And raising debt to do deals can be easier once you’re public as well.
  • Reward employees – Making employees work crazy hours for 5-10 years is tough to pull off, but the lure of an IPO that will make them all wealthy is a great incentive for them to stick around.
  • Market themselves – Especially for lesser-known companies in “boring” industries, an IPO is a great way to increase prestige and attract new investors, partners, and customers.

And sometimes there are technical reasons as well: in the US, for example, the “500 shareholder rule” used to require any private companies with more than 500 shareholders to publicly disclose their financial statements…

…So they might as well just go public and get the other benefits – this was one of the key reasons why Google decided to go public in 2004.

Why is Facebook going public? None of the above!

  • It’s cash-rich and massively profitable, so it has no need for capital.
  • Many of its investors and early employees have already exited by selling to others via secondary exchanges or in late-stage growth equity financings – options that didn’t exist in the past.
  • It has always had a great acquisition currency because its private stock was worth a lot and was actively traded on these secondary exchanges.
  • Come on, does it really need more marketing and hype?
  • And oh yeah, the 500-shareholder rule is in the midst of a revamp and Facebook got around it anyway by issuing Restricted Stock Units (RSUs) rather than actual shares or options to employees as the company grew.

A number of theories have been put forth for why it’s really going public:

  • Some people still think the 500-shareholder rule forced their hand even though it’s being raised to 2,000 shareholders soon.
  • Many believe that long-term capital gains tax rates will increase in the near future – if they go public and employees sell stock now, they’ll pay 15% rather than a potentially much higher rate. You can ask Eduardo Saverin about that one…
  • Others have theorized that they’re using the money for mysterious new monetization methods that will expand their revenue base beyond advertising.

Personally, I don’t buy into any of those as individual reasons – it was likely a combination of some of the points above, plus the fact that late-stage investors still need someone to sell their shares to.

The Downsides of Going Public… and Why Facebook Made IPOs Irrelevant?

Some companies don’t want to go public (or can’t go public) because:

  • They have to give up control and answer to shareholders with quarterly earnings reports.
  • They aren’t VC or PE-backed and therefore don’t need an exit.
  • They’re already highly profitable and have no need for cash.
  • Compliance costs are much higher as a public company due to legislation like Sarbanes-Oxley.
  • They’re too small – it’s tough to go public if you have under $50 million in revenue.

But Facebook changed the rules here because:

1) Mark Zuckerberg maintained far more control than typical founders by splitting the stock into voting and non-voting shares, by controlling the Board, and by selling almost nothing along the way; and

2) It raised $200 million from Digital Sky Technologies (DST) in May 2009, and then an even bigger round of $1.5 billion in January 2011, which effectively gave early investors the exit they needed.

The rise of secondary exchanges like Second Market, where investors can buy and sell private company shares, has made it much easier for early employees to cash out long before the company ever goes public.

(Private company valuation is tricky, but is getting easier over time as the lines between public and private companies blur.)

Who Decides if the Company Should Do An IPO?

In most cases, it’s up to the Board and major shareholders.

So if a private equity firm owns a company and they need to achieve an exit in year 4 or 5 to get acceptable returns, they might push for the company to go public (or get acquired) around then.

And it has traditionally worked the same way with venture capital firms that often end up controlling tech start-ups.

But since Facebook’s CEO owns 28% of its stock and 56% of its voting rights, he has significantly more leeway than the usual founder/CEO – and can make decisions on billion-dollar acquisitions in a weekend without even notifying the Board.

Even with that much control, though, he would not be able to initiate something like an IPO without pulling in everyone else – there’s far too much work to do and too many decisions to be made in the process.

The IPO Process, Part 1 – The Pitch

In most cases, bankers from many firms have been speaking with the company in question and developing relationships for years – so they’re likely to know the company’s intentions well in advance.

If not, the company itself will reach out to bankers and invite them in to pitch for the business.

This is when you, the banking analyst or associate, get to stay up all night crafting 100-page pitch books and hoping you’ve remembered to dot all your i’s and cross all your t’s.

Afterwards, the company selects banks for book runner roles and picks other banks to be co-managers, based on its relationships with them, their pitches, and what the banks have done for them in the past.

Other factors might include banks’ IPO track records and their reputation and relationships with institutional investors.

In the case of Facebook, at first people thought that Goldman Sachs would land the lead role because it helped arrange $1.5 billion of financing in 2011…

But then GS botched the deal by getting on the SEC’s bad side when it included its US clients at first, and then revoked the offer later – resulting in Morgan Stanley winning the lead spot.

Most IPOs have at least 1-2 banks as book runners and then a few more as co-managers; Facebook is unusual because it has 12 banks due to the size and prestige of the offering.

Part 2 – The Kick-Off Meeting

Everyone involved in the IPO – company management, auditors, accountants, the underwriting banks, and lawyers from all sides – attends this meeting.

You spend the day discussing the offering, the required registration forms, figure out who’s doing what, and determining the timing for the filing.

And then you have similar all-hands meetings like this throughout the rest of the process.

It’s actually quite boring for you as a junior banker attending these because you don’t participate too much – you’re mostly just there to take notes.

Ongoing Due Diligence

After that initial kick-off meeting, all the bankers, accountants, and lawyers involved need to do a lot of due diligence on the company to make sure that their registration statements are accurate.

Common tasks here include:

  • Customer Calls – This is probably the most interesting task, because sometimes you hear crazy / interesting things from customers that you’d never learn about otherwise.
  • Industry / Market Due Diligence – You’ll have to research the market, speak with experts, and figure out where it might be headed in the future.
  • Legal and IP Due Diligence – Lawyers handle most of this – it consists of reviewing contracts, registrations, and other documents. Aren’t you glad you don’t want to be a lawyer?
  • Financial and Tax Due Diligence – Accountants do most of this and comb through historical financial statements, tax returns, and so on, and look for irregularities.

Facebook is an interesting example because “customer calls” apply in a different way from what you might expect – their “customers” are not individual users so much as the companies that advertise on the site.

So bankers here likely called the larger advertisers and also spent time talking to key partners such as Zynga.

They might ask questions like:

  • Are you planning to increase / decrease advertising spending?
  • What’s your relationship with the company been like so far?
  • What do you see as key risks going forward?
  • What other social networks do you advertise on, and what do you think of them?

Part 3 – The S-1 Filing

The end result of this entire process, which might take months, is the S-1 Registration Statement (names vary in other countries).

This is where all the juicy information comes out – historical financial statements, key data, who’s selling shares and how many they’re selling, the company overview, risk factors, and more.

When Facebook filed its own S-1, there were so many visitors that the government’s site actually crashed.

The company waits 30 calendar days for comments from the SEC (or equivalent organization in other countries), and the legal team responds to everything once they hear back.

Note that the company never lists projected financial statements in its S-1 – they might have projections internally, of course, but they’re not part of the registration statement.

Part 4 – Pre-Selling the Offering

Once the S-1 is filed and the team is working through revisions, the company can hold a pre-IPO analyst meeting where they educate bankers and analysts on the company and “teach” them how to sell it to investors.

It can also start speaking to investors and issue a “red herring” (preliminary prospectus), which bankers draft (similar to the S-1, but shorter and more focused on sales).

Companies are encouraged to wait until the SEC responds to the S-1 with comments before printing the red herring.

This document may omit the offering price, underwriting discounts / commissions, discounts / commissions to dealers, the amount of the proceeds, and so on – it’s just about selling the company’s story to investors.

Once this document is in place, pre-marketing starts and usually lasts around 2 weeks.

Research analysts meet with institutional investors 1 on 1 and tell them about the company, and sales teams at banks maintain close contact with investors and figure out what they think – do they like the sector? The company itself? What price will they pay?

Based on feedback from these meetings and their own internal valuations, banks set a price range for the offering.

With some companies this can be enlightening; with Facebook it was quite boring because the company had already been actively traded on secondary exchanges long before the IPO, so everyone knew what the rough price range would be.

Picking Investors to Market To

A bank doesn’t just pick the investors randomly – they select firms based on criteria like:

  • Brokerage Commissions – If you’re making tons of money from certain institutional investors, they’ll be high on the priority list.
  • Interest and Track Record – If the firm never does tech investments, for example, the bank may just skip showing them tech IPOs.
  • Potential Brokerage Fees – If a bank wants to win more business from institutions in the future it might show them a “hot” IPO as a favor.

The equity syndicate, sales, and road show management teams handle this process.

Amending the S-1 Filing

After all this pre-marketing work is done, banks amend the S-1 filing with a revised price range based on feedback from investors.

Sometimes there are dramatic shifts in the price range, but it’s more common to see small moves in one direction or the other.

Once again, since Facebook stock had already been actively traded long before the offering, this part of the process likely wasn’t as interesting for them.

Part 5 – The IPO Roadshow

And now for the fun, exhausting part of the process: management gets to travel all over to meet with investors and market the company for 1-2 weeks.

Sometimes management teams make themselves very open and accessible and go out of their way to win over investors and answer questions.

Mark Zuckerberg took the exact opposite approach, mostly because he could afford to – he could show up to 0 meetings and investors would still be falling all over themselves to get shares.

For normal companies, though, this process is extremely important because orders are also taken at this time – investors can state how many shares they want and what price they’re willing to pay.

Management gets daily updates on what the orders are looking like, and the banks involved in the process all try to one-up each other by claiming that they won the biggest orders from investors.

During this time, bankers keep getting more and more feedback from investors and may further revise the price range – that’s why Facebook changed its own range from $28 – $34 to $34 – $38.

It’s a tricky balancing act because no one wants to leave money on the table – bankers want a higher share price so they can earn higher fees, shareholders who are selling obviously want a higher price, and the company wants as high a price as possible to maximize their cash proceeds.

But if the price range is set too high, bankers may have to revise it downward, which sends a negative signal to the market.

During this time, the company might also increase or decrease the number of shares it’s offering – but if it does that too much (in either direction) it may be taken as a negative sign because investors might think the company doesn’t know what it’s doing with the proceeds.

There’s been a lot of debate over both the size of Facebook’s offering (as a percentage of the company, small, but very high in absolute dollar terms) and the price.

Relatively few companies worldwide are actually worth more than $100 billion USD, sand many observers think that Facebook may be overvalued at its current price range and that growth could be flattening out.

Part of what makes Facebook’s valuation so uncertain is that its future business might be far different from what it looks like today – advertising revenue might not even be significant in 5-10 years and payments, mobile, or something else entirely might take over.

Part 6 – The IPO Pricing Meeting

Once the roadshow is over and the order book is closed, the management team will meet with bankers and decide on the final price of the deal based on the orders received.

If a deal is over-subscribed, the company will price the company at the high end of the range and will do the opposite for under-subscribed deals.

Sometimes management will deliberately price the company at a lower price (leaving some money on the table) so the stock can trade up on the 1st day of trading – always a positive indicator to the market.

Usually companies that tank after the 1st day of trading have a hard time recovering and getting back to their initial price.

Feedback was clearly very positive for Facebook, since it set its price at $38 – the high end of the range.

Part 7 – Allocation

Once the deal is priced, the syndicate team of the banks will allocate shares to investors.

While banks try to allocate to investors who will be long-term holders of the stock, banks may be biased at times to reward investors that generate the highest brokerage commissions (e.g. hedge funds who are trade very actively).

The syndicate team usually works overnight to allocate the deal.

Part 8 – Trading

Once the deal is allocated and everyone has their shares, the stock starts trading and “the general public” can buy and sell shares.

So, How Much Do Banks Earn From An IPO?

IPO fees typically range from 3 – 7% depending on the size of the company, how well-known it is, and how much extra work and risk banks have to take on to sell it.

Yes, you read that correctly: for a $100 million offering, banks could potentially make $7 million (now you really understand why they make so much money).

But for extremely large offerings the fee drops, and it drops even further when it’s “hot” and everyone wants to be involved.

So Facebook is only paying bankers a 1.1% fee on its offering, which will still equal $176 million when all is said and done.

For bankers, being involved in the largest tech IPO ever is worth far more than even a substantial increase in fees because they market themselves based on their track records.

Are IPO Fees Justified?

It depends on how much the bankers actually help.

For something like Facebook, the fees are less justified than normal– sure, the bankers help manage the process and do a lot of the grunt work, but who really needs convincing to buy Facebook stock?

The fees are more justifiable for smaller and lesser-known companies that require real selling – and when bankers actually help with addressing key investor concerns and winning more interest in the company.

Back in the day banks used to take on substantial risk themselves by buying the shares first and then re-selling them (“firm commitment”), which they used to justify higher fees.

But this is less common now, so there’s certainly downward pressure on fees.

Will You Be Buying FB Shares?

I’m staying away because great companies don’t necessarily make for great investments.

Also, IPOs have historically under-performed the market by 2-3% – not a great sign if you’re going by statistics.

Of course, by the time you read this the share price will probably have “popped” to a much higher number and I’ll look silly for not having invested.

But we’ll see where things stand after a month, 6 months, or a year.

And if you decide to invest, let us know how it goes and what price you get in (and out?) at.

For Further Reading:


About the Author

Nicole Lee has been serving as an Executive Career & Networking Coach for senior professionals in investment banking, asset management, private equity, and global Fortune 500 companies since 2012.

She has helped 500+ candidates land finance roles at firms such as Morgan Stanley, Macquarie Capital, and UBS.

You can connect with her here.

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Read below or Add a comment

  1. Hi Brian, At what point in the process is the IPO “announced” / revealed to the public?

    1. Usually when the S-1 or equivalent form is filed, but news often leaks out well before that the company wants to pursue an IPO.

  2. Where do bankers hang out in Manhattan, if they ever do?

    1. No idea. I generally dislike bankers and try to avoid them, especially if I’m ever in NY.

  3. nice article~ BTW may I what are the requirements of IPO?

    1. It varies based on industry, region, and exchange, so there’s no universal rule. The NASDAQ requirements are here:

  4. Great piece and helpful for understanding IPO process. Curious how it would look for a company that needs real “selling” from bankers/company vs. a facebook or other unicorn. Say a $50m rev, asian healthcare company…how much convincing for underwriters to sign on and what’s their risk (deal and reputational) when it comes to marketing to potential investors


  6. What if a Big public company say with a global turnover of 50-100 billion (worldwide) , wants to de-list in one of its hottest emerging markets where it gets a turnover of 4 billion and its CEO says , we dont our performance to be judged by market swings but by our own performance , what would you say?

    1. Avatar
      M&I - Nicole

      I don’t quite understand your question?

  7. This is great! And a question –

    So basically, investors (not bankers)will “choose” the IPO’s share price? They will each keep suggesting a price and an average will be taken?

    Do bankers give them a range of where the share price should be? And if so, how was that price range calculated?

    1. Avatar
      M&I - Nicole

      No, investors will indicate a price that they’re willing to invest in. Bankers will then give the feedback back to the issuer. Bankers and issuer will then decide on a price that meets both the company’s needs and investors’ demand. There’s an art to this.

      Yes bankers usually come up with a range based on feedback from investors. They will then revert range to issuers and set up a price range meeting. Once the price range is determined, they will market to investors and seek feedback. Depending on demand and how deal is structured, etc, price range may change. Otherwise, issuers and bankers will usually decide on a price after the pricing meeting.

      1. You’re awesome.

        Can’t wait for M&I’s IPO!

        1. Avatar

          well! they might do better (cost of capital :)) with letters of credit from a retail bank;
          right Brian;


          P.S: awesome work Brian!

          1. Avatar
            M&I - Nicole

            Thanks for visiting our site!

        2. Avatar
          M&I - Nicole

          Ha ha ha ha ha :D

  8. Avatar
    syed tayyeb jan

    nice very nice

    1. Avatar
      M&I - Nicole


  9. Hey Team – solid article. Quick, general thought: it would be great if we could save our favorite articles to refer to at a later time. Just a thought, and you have probably already considered this.

  10. Hello Brian,

    Nice article on IPOs! However, can you do an article on or explain the Non-Public(Private Placement) process?

  11. Avatar
    Obaidur Rehman

    Thanks for the post! Certainly has enhanced my understanding of how the IPO process works. Makes it all the more fun to read when it can related to recent events. Cheers!

    1. Thanks, glad you liked it!

  12. Avatar
    Navraj Singh

    This article is one of the best I have read about FB IPO. It takes the reader from inception to execution of an IPO. Thank you very much for your time you invested in this article.

    1. Thanks for reading!

  13. So happy to see Facebook decline post-IPO. For once the market factors in fundamentals (hopefully?), and realized that a high flyer 70+ PE stock with sketchy plans for making money on its user base is beyond overvalued at current IPO prices. Of course the average retail investor screwed themselves in the process (over 20% of TD Ameritrade’s volume on friday was in Facebook)… but not surprised, hopefully it teaches ppl value wins out in the long-run.

    1. I’m amazed it has been this rational – I honestly thought it might go up to $100 / share, bringing back memories of 1999. I was in SF last week and spoke with a few friends who are no longer investing in anything tech-related because the entire sector is over-hyped / over-valued, except for maybe large, long-standing public companies.

      1. Yes, it was pleasantly surprising for once.

  14. Avatar

    Long time, first time. Awesome insight, and good call! Not enough people read into the risk factors and the fact that Zuckerberg still has a controlling stake.

    1. Yeah, I’ve always thought it was way overvalued and even more ridiculous at the price range they decided on. I’m glad that it didn’t double or do something else crazy because that would just further spur on the hype.

    2. ^ Zuck was never going to give up anything that would jeopardize his controlling share. :P

  15. Avatar

    We need more articles like these. Awesome job Brian.

    1. Thanks! Nicole actually wrote this (I’ve never worked on IPOs – above my pay-grade…) one.

      1. Avatar
        M&I - Nicole

        Brian came up w the idea and edited the article so he is just being humble here.

  16. Great article.
    As a beginner in this field (student), this article gave some interesting views upon IPO’s.
    Thank you.

  17. Very cool article Brian, you should definitely make this a recurring thing, and cover major deals from time to time and provide your insight on them.

    1. Thanks! And yes, we may do more of these.

  18. Amazing article – thank you!

    1. Thanks for your comments!

  19. hi,

    really interesting article. I wish u guys would give us more articles on current affairs such as FB and combine it with something like the IPO process. I think that would be a great concept for the future.


    1. Thanks for your suggestion. I don’t like doing current events-type articles unless it’s something really big because they go out of date quickly and they get very little traffic in the future, but we may do a few more of these in the future.

      1. I know, I have read that reply from you multiple times already (and it makes sense), I just thought combining it with something else like the IPO process makes it stay relevant for a longer time.

        1. Yup and I agree, that’s why we did it here.

  20. Avatar

    “Back in the day banks used to take on substantial risk themselves by buying the shares first and then re-selling them (“firm commitment”), which they used to justify higher fees.”

    So this means now with the allocation process, banks no longer buy IPOs first and sell it. It certainly reduce the risk of not being able to find enough investors. Right?

    So it seems to me that Ibanks don’t bear too much risk.

    1. Yeah, occasionally it may happen these days but it’s less common than decades ago so banks are taking a lot less risk… in most cases. And even when they do buy shares first and sell them, there’s more liquidity in the markets now so there’s arguably still less risk.

      1. Avatar

        Morgan Stanley made only a modest $67mm out of $176 mm. With FB’s terrible aftermarket performance, i bet the gain has been totally wiped out by the stabilization effort in the secondary market, if not worse. the biggest winner is, goldman…

        1. Yeah, could be. I think MS will have a tough time winning another lead book runner spot in the near future for a tech IPO…

  21. Another fantastic post by M&I! I knew the basics about an IPO process but this post has definitely helped in consolidating my knowledge and in fact has further strengthened it (thanks to PWC, as well). I have always been thinking that the reason for FB going public is the 500 shareholder rule!
    Look forward to more such posts.

    1. Avatar
      M&I - Nicole

      Thank you for your support!

  22. Very nicely written!..thank you.

  23. Avatar

    “Of course, by the time you read this the share price will probably have “popped” to a much higher number and I’ll look silly for not having invested”

    should be glad you didn’t..first day showed how exactly the bankers failed in pricing, and not only bankers, Nasdaq failed too, funny..

    1. Yeah, all of that was pretty funny today. I was running around between meetings but saw glimpses in between. Pretty shocked that it traded the way it did.

  24. Hi Brian,
    I just wanna ask you, how much is the spread for the investment bank on an IPO, say if it was just one bank running FB IPO.
    And how much of that spread translates to profit, like how much lawyers would charge, fees etc.

    1. Lawyer fees might be in the low millions and they’re relatively fixed. For banker fees the profit margin is very high – maybe 50-60% because banks have few actual expenses, which is how they can afford to pay out high bonuses.

      For IPOs it might be a bit lower than that due to the roadshow and so on, but it’s still a healthy margin.

  25. Now that we’ve had the FB IPO, we can see that the company and bankers didn’t leave much on the table. There was obviously a battle to keep it from closing below the offer price.

    The collateral damage was seen with LNKD and ZNGA, which have nobody to support them at this point, plus now that it’s easier to own FB, there’s less of a reason to own the smaller players in the social space.

    1. Yeah, very interesting to see what actually happened… I was somewhat surprised that it didn’t pop more even though I thought it was already overvalued.

  26. Definite bubble brewing in the IPO brewery.

    Congratulations to the whole team at Facebook but the company is a black swan, rare, beautiful and it may be gone if they can’t create actual products.

    The US used to be known in the world for creating amazing products (Cadillac, Ford Mustang) but now things in the US seem more geared towards making a tech company this, tech company that – I don’t think Facebook as an investment will last.

    Now if they make a phone on the other hand to tap into emerging markets and actually charge people, that could be something.

    Good article.

    1. I think the economy has just shifted to services/knowledge so it’s not as common to create physical products anymore… their entire service is itself a product. Intangible assets are more valuable than tangible ones now. I think they may change their focus a lot in the next few years but would be shocked if they’re not around.

  27. Great Piece.

    Thank you .

      1. I really like these current event related posts, keep it up!
        On a side note, FB’s purchase of Instagram just before the IPO looks really corrupt.

    1. For information on ipo services and ipo advisory take a look at

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