Initial Public Offerings - The Basics

"IPO" stands for an "initial public offering" of securities. The term is usually used when a business has decided to "go public" to raise substantial amounts of capital by offering ownership interests in the company to the public at large.

The "securities" being offered can include:

• Shares of stock in a company
• Bonds
• Notes
• Debentures
• Evidences of indebtedness
• Limited partnership units
• Memberships
• Other types of investments in a company

A public offering can be a hugely complicated affair. It is usually something that is not undertaken by a company until:

• The company has had a chance to prove itself and has a profitable business model that will scale to much larger operation on a regional, nationwide or even international levels
• The company must also have a strong business plan in place with clear objectives on why it wants to go public. These objectives may include raising millions of dollars of capital to fund an expansion and growth of a very profitable business model.

All offerings of stock and other securities are subject to the federal securities laws, as well as to the securities laws of any state where the securities are being offered or sold. Unless there is an exemption that applies to a given situation, these laws generally require that an offering go through a difficult securities registration process.

There are two federal laws that apply when a company wants to offer and sell its securities to the public:

• The Securities Act of 1933 requires a company to give investors "full disclosure" of all "material facts" relating to the investment, including anything that investors would find important in making an investment decision. This law also requires a company to file a registration statement with the Securities and Exchange Commission ("SEC") that includes information for investors.
• The Exchange Act of 1934 requires publicly held companies to continually disclose information about business operations, financial conditions and management. These reporting requirements are rigorous and continuing. They may apply not only to a company itself, but also to officers, directors and significant shareholders.

Each state has laws that apply to stock offerings and issuing securities. These are sometimes called "blue sky" laws, because they're designed to protect the public against offerings that might be trying to sell nothing more than the "wild blue yonder." These laws usually parallel the federal securities laws to some degree, but state laws vary.

An IPO may involve following not only federal securities laws, but also the securities laws of all 50 states (and the laws of other countries if the offering is extended that far).

A company uses a document called a "prospectus" to disclose all facts about an offering, as required under securities laws. A prospectus can be extremely detailed and lengthy.

There can be severe civil and even criminal penalties if you don't follow the securities laws. Investors who are able to prove they were defrauded can collect money from your company. At a minimum, misrepresenting the facts or failing to follow securities laws when making a securities offering may entitle an investor to a full refund, plus interest and attorneys fees.

Given the complexities of an IPO, many companies going through the process will contract with one or more brokerage houses to "underwrite" the offering. The brokerage house works with the company to place the stock to be issued. Sometimes, this involves the brokerage house essentially guaranteeing the company that a certain amount of capital will be raised, with the expectation that the brokerage house will be able to raise proceeds in excess of the guaranteed amount and pocket the difference.

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