What ACTUALLY happens during an IPO? - Startups 101 | Sidebean

0:00When you need to build up your team to handle the growing chaos at work, use Indeed Sponsored Jobs. It gives your job post the boost it needs to be seen and helps reach people with the right skills, certifications, and more. Spend less time searching and more time actually interviewing candidates who check all your boxes. Listeners of this show will get a $75 sponsor job credit at Indeed.com slash podcast. That's Indeed.com slash podcast, terms and conditions apply. If you need a hiring hero, this is a job for Indeed Sponsored Jobs. This episode is brought to you by Palm Olive. Family time isn't just the big moments. It's weeknight dinners. Sitting around the table, everyone talking all at once. So when the plates are empty and the sink is full, use Palm Olive Ultra. Palm Olive's most powerful formula removes up to 99.9% of grease, leaving your dishes, sparkling clean, and the new convenient pump makes cleaning even easier. So you can spend less time tackling dishes and more time together. Shop now at Palm Olive.com.

1:00Propel Fitness Water With Gatorade Electrolites, Zero Sugar, and Vitamins, Propel hydrates better than water to help you get the most out of your workout and get back to your best self. What propels you? Propel with Gatorade Electrolites. 1, 4, 3, 2, 1. This right here is the ultimate graduation for an entrepreneur. It's the Black Belt, the Academy Award, the Olympic Medal, listing your company in the New York Stock Exchange. Going public. And it's also one of the most complicated, expensive, and dangerous processes a company can go through. Last year, we work almost went out of business because they tried to go public. The young CEOs of today are afraid of going public. Not only is this another startup losing enormous amounts of money. We work the second most money losing IPO. And more recently, as with everything in business, somebody found a workaround, a legal way to cheat the process of going public. A method called a SPAC.

2:01And it may be one of the drivers to the new stock market bubble of the decade. But to understand SPACs and their dangers, we need to understand the whole process of listing a public company in the Stock Exchange. So let's do that today and analyze the potential future of SPACs in this episode of Company Friends. In 2020, the extra trillions of dollars of the US printed for COVID relief have given the stock market a wave of new investors, new retail investors who are buying stocks for the first time. We've got a massive group of individual investors. They've got free trading. They've got fractional shares. They've got all the information that they need. I'm not saying that you are one of them. What I'm saying is that they are there. They exist. And some of them may end up watching this video. So I'm going to get down to the basics to make sure that we are all on the same page. Going public means a company is offering its shares of capital stock to the general public for the first time. This is plenty of implications. For example, data about the company suddenly becomes public.

3:04That's why companies release quarterly updates, which can of course really affect their stock price if they meet or they fail the investors' expectations. In my opinion, by the best core, I've seen some apple. Another implication is that executives of the company are limited in how and when they can sell their own company shares. Otherwise, they risk jail time for insider trading. That is, trading company shares with knowledge that's not available to the general public. Roger Gutt, regularly heard sensitive corporate secret. Billy Walters, insider trading and he is now being found guilty of all charges. Public companies face a lot of regulations and scrutiny. And now before a company is public, they are a private company. So it's a limited number of shareholders. Quite literally what we do at Slightbean for a living is help companies with their pitch and storytelling to get money from these private investors. Yes, YouTube is not how we pay our bills or put our roof over our hands. So this group of private shareholders can include founders, maybe family or friends, venture

4:06capitalists and angel investors. Now before we go any further, I want to make a clarification here, which is that most companies don't go public. Most companies and entrepreneurs graduate by getting a quietage. This is called an exit. That is, when a larger company buys out all the shares from the shareholders and takes control of the company. For example, when Facebook acquired Instagram or when Microsoft acquired Skype and ruined it and we made a video about it. So this is a pretty great outcome for everybody involved, assuming that the acquisition price is good, of course. So you get cash in your bank account, you can retire, you can get a head start, you can have capital to pay your bills or invest in your new business. We also made a video about how much money you actually can get from an acquisition. So check that out. Anyway, we entrepreneurs don't intend to work on the same company for 20 years. You want to build something, launch it, get it to scale and move on. But sometimes the company is maybe too big and nobody can acquire it. That's one of the two most common reasons to go public.

5:08These investors and the founders need a way to sell their shares and cash out of the business. Another reason to go public is that the company needs to raise money to expand. And it has reached a certain scale where they can raise money from the public because now anybody can own company shares in an exchange in a stock exchange. Now most companies doing that will run that fundraising process via an IPO, which is an initial public offering. Ironically, most of the money in that IPO doesn't come from the public. So again, IPOs are mostly for companies that need to raise massive amounts of money from investors and no longer want to limit themselves to those private firms. And doing an IPO is no easy endeavor. A company needs to be healthy because everybody will get a look at their numbers. It needs to prove to the world that it either has thrived or that it has the potential to do so. And there's a long and hard and expensive process to listing a company.

6:08And we've summarized it for you in this video. So step one, the underwriters. Because going public involves so much money, companies usually need to partner with a bank to get them through the entire process. And there are some big names that do this in investment banking. Some of them include Goldman Sachs, so Credit Suisse, JP Morgan, or Morgan Stanley. Everyone, and of course, especially the banks, wants to make sure that the IPO succeeds. So the bank will assign a team of underwriters. And that includes lawyers, accountants, PR, and SEC executives. This team is going to make sure that everything goes well. And most importantly, their goal is that the stock sells at the right price at the ideal event. Of course, investment banks don't work for free. They charge between three and seven percent of the IPO's total sale. Based on that number, we can infer that on Airbnb's IPO, for example, the underwriters, Morgan Stanley and Goldman Sachs, could remain between 105 and 200 million dollars on the transaction.

7:08And in case you're wondering where the term underwriter comes from, there's a funny story behind that. When you need to build up your team to handle the growing chaos at work, use Indeed Sponsored Jobs. It gives your job post the boost it needs to be seen, and helps reach people with the right skills, certifications, and more. Spend less time searching, and more time actually interviewing candidates who check all your boxes. Listeners of this show will get a $75 sponsor job credit at and.com slash podcast. That's indeed.com slash podcast, terms and conditions apply. Need a hiring hero? This is a job for Indeed Sponsored Jobs. This episode is brought to you by Paul Molliv. Family time isn't just the big moments. It's weeknight dinners. Sitting around the table, everyone talking all at once. So when the plates are empty and the sink is full, use Paul Molliv ultra. Paul Molliv's most powerful formula removes up to 99.9 percent of grease, leaving your dishes sparkling clean, and the new convenient pump makes cleaning even easier, so you can

8:09spend less time tackling dishes and more time together. Shop now at PaulMolliv.com. For Paul Fitness Water, with Gatorade Electrolites, Zero Sugar, and Vitamins, propel hydrates better than water to help you get the most out of your workout and get back to your best self. What propels you? Propel with Gatorade Electrolites. So back when shipping was essential and much more dangerous than today, wealthy people were willing to cover the risk that the ship's based in storms, so ship owners would write a document describing the ship's worth and what they carried in value. For a profit, rich businessman assumed the risk associated with that specific shipping route, and they would sign their name under the amount that they were willing to put in, hence the name underwriter. So they became the first kind of insurance agents. Another fun fact on underwriters, Stratton Oakland was the underwriter of the Steve Madden IPO. That's the wolf of Wall Street Story. The guy ended up going to jail for faking documents and pumping the value of their stock,

9:15with the occasional exception. The underwriter is going to guide the company through this entire process and they will underwrite. That means they're going to provide a guarantee to the company to sell a specific amount of stock during the IPO process. Now remember, an IPO looks to raise costs. Capital by selling shares to new investors. So should they fail to convince prospective investors to buy shares in this company, the underwriter needs to buy the surplus. And that is generally that business. Of course, to avoid having to spend a lot of money on a failed IPO, the underwriter therefore works especially hard to sell all available shares. And then, when the company executives often go on a road show across the country to get firms to commit to buying shares when they go public. If the underwriter ends up with a lot of unsold shares, well, they can still put them in the market, but they need to be very careful with that because suddenly dumping a lot

10:17of shares can drag the price down, which hurts everybody in the transaction, including themselves. Now the next step is fascinatingly bureaucratic. It's the due diligence. And of course, you cannot put aside paperwork. And a lot of an IPO process is just that. It's paperwork. About three months before the actual IPO date, the team must present documents that include first, an engagement letter, then a letter of intent, then an underwriting agreement, a red-haired document, and an S1 registration statement. So let's talk about the S1 registration, which we've mentioned a few times in our previous episodes. It's a crucial bit of information. If companies want to be a part of this national public stock exchange like NASDAQ, they have to turn in this form. It's the company saying, hey, I might go public soon. So news outlets are always in the lookout for when an S1 statement is filed. And the most important part of the S1 form is the prospectus, which is a legal document that requires information on the business operations, the use of proceeds, total proceeds, the price

11:20per share, a description of management, the financial condition, the percentage of the business being sold by individuals and holders, and then the information on the underwriters. Oftentimes, an S1 filing is the first look the public gets at what's really going on inside a company. It was the absolutely ludicrous S1 form filed by WeWork that brought the company down. And at the company acknowledged how much money it was burning, billions of dollars, the insane spending by the CEO, and the unrealistic company vision. Most importantly, it revealed how WeWork was this pretty boring, realistic company disguised in fancy textures. We also made a video about that. So once all these documents are ready, it's time for the next step, which is filing for review. And you might have heard of this in the news. X company has filed its IPO. Confidentially filed for an IPO with the SEC. It's a huge deal. It's 17 billion to 100 billion. Or Dash has done here financially is impressive. Well, all of these documents are sorted and delivered to the SEC.

12:22And the SEC does a thorough revision of the dog's literature. Everything is in order. It's common for us to hear about the SEC regulating this or checking on that. And yes, the commission has this party pooper image, but very much at the point. By the way, during this time, the company must enter what's called a quiet period, in which information disclosed by the company about their status should follow very careful guidelines. Then comes step four, which is defining how much and how many. And at this point, the team is hard at work defining the number and the price of the shares that they're going to put up for sale. The catch here is that each IPO is different. It depends on many variables, which can change from company to company. And of course, the investment bank needs to make up the money for the underwriting and a profit. And what you have to consider factors like the company demand. Do we expect people to buy these shares? Well, there's of course the market itself. An IPO before the dog come crash is not the same thing as an IPO a few months later. And finally, there's the challenge of setting the price. That initial share price can be too high, because otherwise people won't buy.

13:23And if it's too low, the company effectively leaves money on the table. Some notable examples on IPO price, Facebook IPO'd at $38 per share, and closed the day at $38.32. So this could be seen as a well priced IPO. Airbnb on the other hand, the price, the IPO, at $68 per share, and closed the day at $146. I'm oversimplifying here, but that potentially means that they underpriced their IPO. There was more demand for their shares than they anticipated. Now of course, this is a very delicate game, but it's aided by a process called Stabilization, because all this work can go belly up in a matter of days or hours. So immediately after the IPO, the underwriters take part of this process. In short, they buy enough shares for the market price to stabilize. It's a supply and demand game. If the shares aren't selling, then the prices will drop. So underwriters can do a series of purchases and sales to make it seem as though demand is up. And yes, it does sound like cheating, but it works.

14:24And there are mainly two ways to go about it. The first one is using the green shoe option. So underwriters. When you need to build up your team to handle the growing chaos at work, use Indeed Sponsored Jobs. It gives your job post the boost it needs to be seen, and helps reach people with the right skills, certifications, and more. Spend less time searching, and more time actually interviewing candidates who check all your boxes. Listeners of this show will get a $75 sponsor job credit at Indeed.com slash podcast. That's Indeed.com slash podcast, terms and conditions apply. Need a hiring hero? This is a job for Indeed Sponsored Jobs. This episode is brought to you by Palm Olive. Family time isn't just the big moments. It's weeknight dinners, sitting around the table, everyone talking all at once. So when the plates are empty and the sink is full, use Palm Olive Ultra. Palm Olive's most powerful formula removes up to 99.9 percent of grease, leaving your dishes sparkling clean, and the new convenient pump makes cleaning even easier, so you can spend less time tackling dishes and more time together.

15:27Shop now at Palm Olive.com. Stock in a certain amount of time. If the IPO is a huge hit, pre IPO shareholders might want to dump their shares for profit, and the market floods, and then the price drops. So the lock up prevents this.

16:28Now, all of this sounds like a cheat code, but it's legal, and the SEC allows it. All the underwriters have to do is set the conditions in writing in the contract. And once the period is over, everything goes public. The underwriters no longer have any control, and then the market dictates whether the stock goes up or down. They decide whether they like the stock or not. As for me, I like the stock. Winners are winners, losers are losers, and the stock market continues in its crazy ways. And after that, it's smooth-sale. Alibaba underpressure again today. The shares of the Chinese tech company falling. I've never seen it before. What Wall Street bets was just really... So let's talk about direct listings now. Direct listings are used when the company wants an exit, but doesn't really need to raise any additional capital. In a direct listing, we'll take those existing shares and just put them on the market. With an NYC direct floor listing, that price discovery is happening here on the trading floor. And direct listing, potentially, 100% of the shares are tradable. Let's say the founder of a company owns 10% of their business after going through multiple rounds of funding.

17:29That business, according to the latest valuation, let's, in an example, is maybe worth $500 million. So this founder's net worth is $50 million, but he can't really do much with that money. Does he believe in the company? Yes. Will he or she hold most of their shares? Because they believe they can continue to increase in value? Yes, of course. But they also probably want to pay their mortgage or diversify their portfolio. Or I don't know, get that Tesla that they've been wanting to buy, or maybe invest in other startups, or maybe even attend Wimbledon for Roger Federer retires, because it's his idol and he's tried to fly to see him play twice, but the plans were ruined both times by a military curve for you in Bogota, and then him getting knee surgery, and finally, a global pandemic. But the most commonly used approach to sell these shares is to do a direct listing, which is what Spotify and Slack did to go public at the time. Both of these companies had a significant presence in the market and in the people's mindsets, so they were doing well, and at the time there was no possible buyer,

18:31and the founders and the shareholders needed a way to cash out of their investments. So the steps to doing this are pretty similar. You still have to file an S1 with the SEC. You still have to get it reviewed. You have to go to a quiet period, and it's all a boring deja vu. The biggest difference is that there is no underwriter. The company saves a lot of money by not going through a bank, but at the same time, the transaction is much riskier, unlike the IPO in which the share price is negotiated beforehand, and a direct listing of the price of the stock depends on supply and demand. This of course increases volatility, as a range in which the stock is traded is less predictable. In both cases, the added costs of being a public company, including the financial, the compliance experts, the filings, the advertisers, the more experienced executives, can add up to around $2.5 million a year, just in case we're considering. But now let's talk about SPACs. Let's say that you want to skip all this hassle and get right to business.

19:32That's pretty much what SPACs are about, and why they're so risked. Has we hit SPACs? Special purpose acquisition company. SPACs have existed for decades. The process for SPAC is pretty simple and straightforward. So SPAC stands for Special Purpose Acquisition Company. The way it works is that one, a well-known investor, which we're going to call the sponsor, decides to raise funds for their SPAC. Their SPAC is essentially an empty company that doesn't do anything. It just has funds provided by the investors. Step two, the purpose of this shell company is to buy another real operating business. But they can't disclose what this company is. The whole idea here is that if the investors can raise the funds for the SPAC, say $100 million, they're going to take this shell company public. If they disclose what company they intend to buy, the regulation makes it much more complicated. So hence the common name for SPACs, blank check companies. Step three, the IPO is, it was very easy. The company has no trade, no historical numbers.

20:33It's just a pile of cash. So going public is easy and cheap. And once the company is public, step four, the pile of cash can be used to acquire a real company. The two companies merge and now the real company that they just acquired becomes the public company. But it effectively avoided the S1 filing. It avoided the scrutiny and the underwriters. So SPACs are usually launched with a simple, round $10 for a share price. You average investor can get in on that company when it gets listed on the stock exchange. But again, there is no way of knowing which company will be eventually acquired. You are just putting your trust on the sponsor and the team behind the SPAC. And that definitely has this celebrity variable. Shaquille Niel, Stephen Curry, Serena Williams, and even Colin Kaepernick have all been involved in SPACs. And if we look at their rules for SPAC, we can begin to find stuff that raises eyebrows, the person who launches the SPAC to the sponsor and their first investors get a heavy discount on their shares. Essentially, they get to buy 20% of the company

21:36for fractions of a dollar, while all the other investors have to come in 10 dollars per share. Well, the company that gets acquired doesn't really suffer from this SPAC. When you need to build up your team to handle the growing chaos at work, use Indeed Sponsor jobs. It gives your job posts the boost it needs to be seen and helps reach people with the right skills, certifications, and more. Spend less time searching and more time actually interviewing candidates who check all your boxes. Listeners of this show will get a $75 sponsor job credit at nd.com slash podcast. That's nd.com slash podcast, terms and conditions apply. Need a hiring hero? This is a job for Indeed Sponsor jobs. This episode is brought to you by Paul Molliv. Family time isn't just the big moments. It's weeknight dinners, sitting around the table, everyone talking all at once. So when the plates are empty and the sink is full, use Paul Molliv ultra. Paul Molliv's most powerful formula removes up to 99.9% of grease, leaving your dishes sparkling clean,

22:36and the new convenient pump makes cleaning even easier, so you can spend less time tackling dishes and more time together. Shop now at PaulMolliv.com. Investors do. Their cash essentially gets diluted 20% on the spot. Another rule is that the SPAC needs to complete a company purchase within two years, usually. And if that doesn't happen, there's a clause that requires them to return the money to the investors. That's all of grades. But the SPAC manager has an incentive to get a company acquired, any company, so that they can make that beautiful 20% commission. The investors on the SPAC do get to vote in what company gets purchased. But if the clock is ticking, you're running out of time, that might put pressure on doing a deal faster that might not be such a great deal.

23:37And that's just my skepticism on the basic rules of the SPAC. Let's start with some anecdotal examples of companies that have gone public via SPAC. Nikola is an example. We made another whole video about them. And if you look at the chart, you'll see the period at $10 before the acquisition was completed. And then an insane spike in value up to a peak of $64. And then down back to 11 as a writing. The seemingly most successful SPAC in 2020 was a company called QuantumScape that was focused on battery technology. They reached a peak value of $84. And they're down to $32. A brighter story is draft king, a digital sports entertainment company that went from $10 to $57. And they seemed to continue to grow. Virgin Galactic also went public via SPAC to stock went up 35% in 2020, reached a peak of $54 in February 2021, but then crashed back down to $21 at the time of writing. That's all anecdotal. But what does aggregated data tell us? Of the 313 SPAC IPOs since the start of 2015,

24:40Renaissance Capital analyzed 93 that had completed mergers and had taken a company public as of October 2020. Of these, the common shares have delivered an average loss of 9.6% and a median return or loss of 29% compared to the average after market return of 37% for traditional IPOs in this period. Only 31% had positive returns as of that date. So Harvard went even further with a study of 47 SPACs that happened between January 2019 and June 2020. This paper, which I have linked in the description, drew a line between high quality and low quality SPACs. High quality SPACs are those sponsored by high-profile equity firms or former CEOs of Fortune 500 companies. High quality SPACs had a return of 31% by the three month mark, 15% at the six month, and minus 6% at the 12th month. Low quality was negative from the start from minus 4% to minus 34% at the 12th month mark.

25:42Now the data doesn't really lie here. Everybody seems to agree that these transactions don't perform well, but it seems that people just ignore the data sometimes. This is the number of SPACs in the US since 2009. That bar in 2021 is March 2021. So we have nine months ahead of us. People have been pouring money into these things like never before. Bill Atman did a so-called SuperSFAC called Pershing Square Contain Holdings, PSTHU, which raised $4 billion and became the largest SPAC offering of all time. And that of course happened last year, pandemic year. 308 SPACs have raised almost $100 billion so far this year, according to SPAC Analytics. These are blank check companies that are not producing anything and their value drives up just based on the hype of what they might acquire. It's inevitable to compare them to the Donkum bubble, but I got a lot of shade for doing that in our video

26:42from a couple weeks back. Remember, these are companies that will need to merge acquired something that's 1,000 plus mergers expected this year just from SPACs that haven't done it yet and their clock is ticking. Remember, 99, there were 489 IPOs right before the Donkum bubble first. And since then, there has never been a match in the number of new public companies. Some reasoning seems to have hit the market and a lot of SPACs sold heavy crashes in February. We've only seen about 10 SPAC deals this month. SPACs are not a way around security laws. Very frenetic pace. The SEC started inquiry. The number of news SPACs expected for April went down to zero. These news are probably going to change as we finish editing and producing this video. It's April 6th today, so apologies. It delayed. It's information is late, but if you want the fancy slow-mo shots and the charts and the animation, that stuff takes time. Speaking of which, I told you this YouTube channel,

27:42as much as we compulsively check the comments and the activity on these new videos, is not really what puts a roof over our heads. We at Slidebean, we are storytellers, and we help companies tell the right story to their investors through a pitch deck. You can use our AI Power Tool and create a pitch deck minutes, or you can get our team of writers, entrepreneurs, and financial analysts to do that for you. We've helped hundreds of companies race capital. More recently, just to give you an example, we helped build the deck for a company called Upkeep that raised a $36 million Series B. So be sure to check out Slidebean.com. Now, all hail the mighty YouTube algorithm. Help us feed it by subscribing, liking, or commenting, on whether you like this story or not. We'll see you next week. The season's most desirable menu has returned to sweet green.

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