Reading: The Going Public Process

The aspects surrounding diligence and regulatory disclosure that we have discussed in the previous section are crucial elements on the way to bringing a firm public, and they constitute areas where the underwriting syndicate can add value with its experience, resources, and reputation.

In many instances, however, the key contribution of the underwriting syndicate comes from the marketing of the securities. Bringing a company to the public market is often not as easy as it sounds. The reason is that there is tremendous information asymmetry between the issuing firm and the investing public. This information asymmetry is primarily driven by the following 3 factors:

•  Firm life cycle: The issuing firms are often young and have limited track record, so that their innovative ideas and business models might be difficult to understand for outsiders. Financially, they tend to have negative cash flows and great uncertainty about the odds of success. In fact, approximately 80% of all firms that go public have negative earnings per share. Moreover, they have few real assets so that their valuations are primarily driven by intangible assets. 

• Disclosure: Private companies do not have to disclose much information to the public. In fact, to protect their business ideas from imitation by competitors, they often try to stay outside the public eye. In many instances, it would therefore seem fair to say that, before the decision to go public, the issuing firm was not on the radar of many institutional and private investors who trade on public markets.
   
• Costly information search: Smaller individual investors have limited incentives to inform themselves about the issuing firm, as they would bear the full cost of that information search while only capturing a fraction of the benefits that corresponds to their potential ownership stake in the company. All other shareholders could free-ride on the investor's search efforts.

One of the key tasks of the underwriting syndicate is to dismantle that information asymmetry between the listing firm and the investing public. Basically speaking, there are two main phases in the marketing of an IPO, the pre-registration marketing and the so-called roadshow.

Pre-Registration Marketing 

The underwriter's and the issuer's marketing efforts often start long before the firm officially files for an IPO. The purpose of these pre-marketing efforts is to create momentum for the firm and onboard strategically important investors. Depending on the underwriter, such investors are often called pre-IPO investors, cornerstone investors, or anchor investors. They tend to be the most valued customers of the underwriter, including sovereign wealth funds, family offices, pension funds, and other leading private or institutional investors.

These investors are invited to subscribe shares prior to the IPO, often at favorable conditions. Their investment increases the popularity of the issuing firm and signals quality to potential IPO investors. 

Just imagine a firm managed to place shares with Warren Buffett or another legendary investor prior to the IPO. The sheer presence of such an investor will make it much easier to sell the firm's shares to IPO investors, as the firm is now certified by that investor.

Post-Registration Marketing: Roadshow

Once the firm has filed for an IPO, the investment banks and the issuing firm embark on a "roadshow," during which they meet with potential IPO investors across the country or around the world. The purpose of the roadshow is to tell the story of the firm in a convincing way and to solicit indicative orders from the investors.

Running a successful roadshow is often easier said than done, as most of the investors that participate in these events are very experienced and savvy, while some of the issuer's top executives might do such presentations for the first time and speak a different language than finance professionals. Therefore, the underwriter usually plays a very important role on the show.