IPO Terms and Definitions
Here are some commonly used terms in the IPO market.
American Depositary Receipt - ADR – A negotiable certificate, which is issued by a U.S. bank and traded on a U.S. exchange, representing a specified number of shares in a foreign stock. ADRs are denominated in U.S. dollars, with the underlying security held by a U.S. financial institution overseas. ADRs help to reduce administration and duty costs that would otherwise be levied on each transaction.
Aftermarket Performance – Using the offering price as a benchmark, this is method in which the performance of a new IPO is tracked
All Or None - AON – A condition used on a buy or sell order to instruct the broker to fill the order completely or not at all.
Best Efforts – An agreement made by an underwriter to act as an agent between an issuing company and investors, but does not guarantee the amount of stock to be sold to the public.
Bond – A debt investment with which the investor loans money to an entity (company or government) that borrows the funds for a defined period of time at a specified interest rate.
Bought Deal – A new share issue that is bought entirely by one underwriter to resell to investors.
Direct Public Offering - DPO – Where a company raises capital by marketing its shares directly to its own customers, employees, suppliers, distributors and friends in the community. DPOs are an alternative to underwritten public offerings by securities broker-dealer firms where a company's shares are sold to the broker's customers and prospects.
Expenses –
- Money spent by a firm to continue its ongoing operations.
- Money spent or costs incurred that are deductible and reduce your taxable income.
Firm commitment – An agreement made by an underwriter to act as an agent between an issuing company and investors, and guarantees that a certain amount of stock will be sold to the public.
Flipping – When an investor buys an IPO then quickly sells it to make a quick profit similar to in the housing market. This is generally viewed as a bad investment policy.
Greenshoe Option – Legally referred to as an over-allotment option, a provision contained in an underwriting agreement which gives the underwriter the right to sell investors more shares than originally planned by the issuer. This would normally be done if the demand for a security issue proves higher than expected.
A greenshoe option can provide additional price stability to a security issue, since the underwriter has the ability to increase supply and smooth out price fluctuations if demand surges too high.
Gross Spread – The difference between the underwriting price received by the issuing company and the actual price offered to the public.
Initial Public Offering - IPO – The first sale of stock by a private company to the public. IPOs are often issued by smaller, younger companies seeking capital to expand, but can also be done by large privately-owned companies looking to become publicly traded.
In an IPO, the issuer obtains the assistance of an underwriting firm, which helps it determine what type of security to issue (common or preferred), best offering price and time to bring it to market.
Also referred to as a "public offering".
Lead Underwriter/manager – This is the person ultimately responsible for the IPO. They manage the offer and allocation of shares process.
Lock-Up Agreement – A legally binding contract between the underwriters and insiders of a company prohibiting these individuals from selling any shares of stock for a specified period of time. Lock-up periods typically last 180 days (six months) but can on occasion last for as little as 120 days or as long as 365 days (one year).
New Issue – A reference to a security that has been registered, issued and is being sold on a market to the public for the first time. New issues are sometimes referred to as primary shares or new offerings. The term does not necessarily refer to newly issued stocks, although initial public offerings are the most commonly known new issues. Securities that can be newly issued include both debt and equity.
Offering Price – The price at which publicly issued securities are made available for purchase by the investment bank underwriting the issue. A security's offering price includes the underwriter's fee and any management fees applicable to the issue.
Opening Price – The price at which a security first trades upon the opening of an exchange on a given trading day.
Oversubscribed – A situation in which the demand for an initial public offering of securities exceeds the number of shares issued.
Penalty Bid – A bid intended to facilitate a securities offering by stabilizing its price during the distribution period. This bid is typically entered by the managing underwriter on behalf of a syndicate.
Pipeline –
- An investment company whose purpose is to collect investment funds from a pool of individual investors and invest them in financial securities.
- The underwriting procedure which must be completed by the Securities & Exchange Commission (SEC) before a security can be offered for sale to the public.
Prospectus –
- A formal legal document describing details of a corporation. The prospectus is generally created for a proposed offering (usually an IPO), but it can still be obtained from existing businesses as well. The prospectus includes company facts that are vitally important to potential investors.
- In the case of mutual funds, a prospectus describes the fund's objectives, history, manager background and financial statements.
Quiet Period – In terms of an IPO, the period where an issuer is subject to a SEC ban on promotional publicity. The quiet period usually lasts either 40 or 90 days from the IPO.
Red Herring – A preliminary registration statement that must be filed with the SEC describing a new issue of stock and the prospects of the issuing company.
Registration –
- The process by which a company files required documents with the Securities and Exchange Commission detailing the particulars of a proposed public offering. A company issuing shares must reveal essential facts and detailed information about its business during the registration process, including a business and asset description, a description of the security being offered and the details of that offering, a description and names of the company's management, and the company's financial statements, which have been certified by an accountant working independently of the company.
- The process by which securities brokers or dealers become legally entitled to sell securities. To have the authority to sell securities, a broker or dealer must file forms and be granted registration with the SEC, must already be a member, or must become a member of a self-regulatory organization such as the FINRA, be registered with the state or states in which he or she intends to sell securities if such state laws require him or her to do so, and finally, be or become a member of the Security Investor Protection Corporation.
Revenue – The amount of money that a company actually receives during a specific period, including discounts and deductions for returned merchandise. It is the "top line" or "gross income" figure from which costs are subtracted to determine net income.
Revenue is calculated by multiplying the price at which goods or services are sold by the number of units or amount sold.
Road Show – A presentation by an issuer of securities to potential buyers. It is intended to create interest in the securities.
Selling Shareholders – These are the officers (shareholders) of the offering company who are selling their shares. It is generally considered a bad sign if the shareholders are selling their shares at the IPO level.
Spinning – The practice of brokerage houses exchanging IPO shares with top executives for reciprocating business from their companies.
Syndicate – A group of bankers, insurers, etcetera, who work together on a large project.
Tracking Stock –
- Common stock issued by a parent company that tracks the performance of a particular division without having claim on the assets of the division or the parent company. Also known as "designer stock".
- A type of security specifically designed to mirror the performance of a larger index.
Underwriter – A company or other entity that administers the public issuance and distribution of securities from a corporation or other issuing body. An underwriter works closely with the issuing body to determine the offering price of the securities, buys them from the issuer and sells them to investors via the underwriter's distribution network.
Venture Capital – Financing for new businesses. In other words, money provided by investors to startup firms and small businesses with perceived, long-term growth potential. This is a very important source of funding for startups that do not have access to capital markets. It typically entails high risk for the investor, but it has the potential for above-average returns.