Investment Banking For Dummies. Matthew Krantz

as part of the responsibility of the investment banker. To be clear, the investment banker can’t do anything to change the way the company is being run — that’s up to the management team of the company. Still, there are levers that the investment bankers can pull to keep the IPO working for all parties, at least in the very short term.

      Holding the insiders hostage with lockups

      Just about the last thing IPO investors want to see is all sorts of selling by officers and directors the second after a company goes public. Think of it this way: Stock prices are set by supply and demand. If after a company goes public, employees and officers start dumping their stock, the market will be swamped with a supply of stock and push down the price of the shares. This unleashing of supply could create an avalanche of selling, not to mention spook investors by the strong negative signal it sends.

To prevent this downward spiral, investment bankers help companies create a lockup period (a set period of time during which the officers and directors are prohibited from selling shares). Lockup periods come in all types and can be customized by the company and its investment bankers.

      

Modern IPOs are increasingly using a style of lockup period that expires gradually over time. Usually, the investment banks want to lock up all insider sales for at least 90 days after the IPO to give the fledgling stock a good period of time to find a natural equilibrium between buyers and sellers. After 90 days, the first group of insiders will get the green light to sell. After that first lockup comes off, another group of shares may be released after 180 days and another group after 365 days. By spacing out the lockup expiration dates like this, the investment bankers can somewhat control the flow of stock into the market.

      Quiet periods

      Regulators get a bit touchy when companies start looking to sell stock to the public for the first time. Securities regulations are in place to curb any activities that will fool investors into buying investments where the sellers know they’re a bust. Regulators and investment bankers work together to control the information that a company and its officers parse out to investors prior to an IPO and right after it’s done.

      A company is prohibited from engaging in promotional activity to push up the value of its IPO, usually prior to the IPO and up to three months afterward. Investment bankers, too, must watch what they say and stick to the facts and not use promotion. It’s a fine line, for sure. After all, part of the IPO process includes roadshows (visits with potential investors). Talking about the IPO or the company is not illegal. In fact, it’s essential — full disclosure is the point of the IPO process. But the key is that the company and investment bankers can’t get promotional and make misleading promises about the company’s prospects.

      Follow-on and secondary offerings

      Raising money from the capital market can be like plastic surgery in Hollywood: Once someone gets started, it can be hard to stop. Similarly, once a company raises money from investors by selling stock to the public, that’s usually not the end of the process.

      Companies, with the help of their investment bankers, can come back another time to raise money with a follow-on offering. During a follow-on offering, companies can sell additional shares to the public. These offerings can generate more capital for the company, which may help it turbocharge its growth. But in the process, the company is also creating new shares and selling them. And when the additional shares hit the market, they dilute the value of the existing shares, or make them worth less because the company is carved into more pieces. The underwriter is closely involved in these follow-on offerings.

The word dilution is like poison with investors. Any move by a company that increases the number of shares and reduces the value of each share is typically frowned upon by existing investors.

      Another time additional shares may go to market is in a secondary offering. Secondary offerings allow significant current investors to sell their shares in an organized fashion, after the IPO. Secondary offerings are not dilutive because no new shares are created. The shares existed before — they were just held by insiders. Insiders are simply selling shares they had before.

      What are unicorns?

      Some companies resist or put off selling shares to the public as long as possible. They might postpone an IPO because they don’t need the money, as they have patient investors not in a hurry to cash in. Some companies might prefer to stay private so they don’t have to worry about the requirements of being a public company. But for whatever reasons some companies stay private for a long time, a small few get very large. These companies, which generally see their valuations balloon to $1 billion or more, are so rare that they’re called unicorns. Just as you’re not likely to see a unicorn grazing in the fields, private companies able to hit valuations of $1 billion are rare, too. Yet, in 2019 investors spotted two unicorns: ride-sharing company Uber Technologies and corporate collaboration Slack. By the time they became public companies, Uber and Slack were worth $8.1 billion and $7.4 billion, respectively.

Seeing What Sell-Side Analysts Do

      When companies decide to go public, there’s no shortage of investment bankers who are lining up to get the job. The fees associated with underwriting an IPO can be significant, so just about every investment banking firm would be happy to get the piece of the deal.

      Because of the intense competition for deals to bring companies public, investment bankers often have to sweeten the pot and pitch all the support they can provide to the deal.

      

One thing nobody wants to happen, and that includes companies and investment bankers, is for the IPO to break, or fall below the offering price. Companies worry that if they become just one of the thousands of stocks available for trading, they may get lost in the Wall Street shuffle.

One way investment bankers allay this concern is by offering aftermarket research support. Most large investment banking operations employ teams of sell-side analysts who research companies, including many of the ones that the investment bank brought public, and produce reports to tell investors if the stock is worth a look.

      The goals of the sell-side analyst

      The sell-side analyst at a firm that does investment banking has a somewhat complicated job. Their primary job is to use fundamental analysis (the ability to determine the value of a company examining the details of the business) to help investors decide whether to invest. But here’s where things get complicated. Sell-side analysts are writing about companies that just so happen to be some of the investment bank’s best clients and generate large fee income from IPOs, mergers, or follow-on offerings.

      Given the conflicts that sell-side analysts face, it’s important to understand the roles that these professionals serve, including the following:

       Protecting new stocks from being lost and forgotten: When a company goes public, it’s suddenly in competition with thousands of other publicly traded companies. There are massive companies with huge market values, like Microsoft and Exxon Mobil, in addition to small and midsize companies. Investors have no shortage of choices when it comes to finding stocks to buy.Reminding investors to take a look at a newly public company is one role of the sell-side analyst. By providing research coverage on a newly public company, the sell-side analyst is drawing attention to that stock. And having analyst coverage from a major Wall Street firm is a way for a company to avoid being an orphan (forgotten stock) with investors.

       Performing surveillance for investors: Pity the poor mutual fund manager. These buy-side investors need to scour Wall Street for the very best investments that