Which Requirements Need to Be Met to Make an IPO Happen? - dummies

Which Requirements Need to Be Met to Make an IPO Happen?

By Matt Krantz, Robert R. Johnson

Investment bankers can concoct just about any financial product out of thin air. And some of these products indeed make investors’ money go poof. But IPOs aren’t created out of nothing. An IPO at its core requires a willing company that’s looking to raise money by selling part of itself to willing investors.

And for an IPO to be successful — in that it attracts ample investors to pay a healthy price for the stock — the bar is even higher. A few characteristics of a company that is often a prime candidate for a successful IPO includes being in the following:

  • An industry investors are interested in: IPO investors often get infatuated with certain investment themes. When an industry catches the attention of investors, there’s usually ample appetite for several key players to go public as investors lap up the shares like hungry wolves.

    The best example of an industry that IPO investors couldn’t get enough of was the Internet. During the late 1990s and early 2000s, just about any company with an e before its name or a dot-com after it was able to sell stock to the public and get a huge valuation.

    Year Total Number of IPOs Number of Internet IPOs Percentage of IPOs That Were Internet Companies
    1998 322 40 12.4%
    1999 504 272 54.0%
    2000 397 149 37.5%

Source: Jay Ritter, University of Florida

  • A fast-growth period of its lifecycle: Companies often love IPOs because they can raise money without actually agreeing to ever give that money back or even pay interest on it. IPOs can be a great deal for the company compared with other ways of raising money, which require interest payments. That said, investors are a fickle bunch.

    If they’re not going to get paid a predictable return, they generally want the promise of something else. And that something else is usually a piece of a company with explosive growth. Investors routinely examine a company’s growth rate to make sure it’s expanding faster than the average company to see if it’s worth investing in.

    Hopes for rapid growth were a key element in the May 17, 2012, IPO of Internet sensation Facebook. The company raised more than $16 billion from investors, making it the third largest U.S. IPO of all time and the biggest technology IPO ever, according to Renaissance Capital. Facebook was certainly putting up huge growth. The company posted 154 percent revenue growth in 2010 and 88 percent revenue growth in 2011.

    Those massive rates of growth were more than enough to get the attention of investors. But sometimes companies go public when they’re peaking so they can sell their shares at a rich price. More than a year after its IPO, shares of Facebook were still below the price they fetched when they were initially sold to initial investors.

  • Strong competitive advantage: If investors are going to take a risk on shares of a newly established public company, they want to make sure they’re protected a bit. One way investors can feel good about their investment is betting on a company that has scarce competitors and very high barriers to entry (meaning, it would be costly for a competitor to take on the company in the product marketplace).

    Many massive IPOs fit this category. Visa and UPS are the no. 1 and no. 11 largest U.S. IPOs ever, having raised $17.9 billion and $5.5 billion, respectively. Both of these companies really only have a handful of serious competitors and are protected by the fact that massive investments in equipment would be needed for anyone to even dream about taking them on.