1. Going Public – IPO Lecture

2. Venture Capital Process Seed Money 1st Round Financing 2nd Round Financing Clean-up Financing Year 1 Year 3 Year 5 Private Investment Venture Capital Firms

3. Going Public - Details  Forms (audited financials)  S-1 (large offerings)  SB-1 (<$10m)  SCOR (<$1m)  Direct Public Offering (DPO)  Usually issue 20-40%  Primary v. Secondary issue (unseasoned v. seasoned)  Investment Bankers )  Due Diligence  File with SEC  Market securities  Preliminary Prospectus ( “ red-herring ” )  File S-1 documents  “ Road Show ” to potential purchasers (mutual funds)  Costs (7% spread, underpricing IPO)

4. The benefits of IPO  Enhance the corporate’s reputation  Increase the game capability with the financial institutions  Establishing a new raising funds method by capital market  Received the capital advantage in more cheaper funds

5. IPO process  On the Road  Underwriters and management team put together road show for prospective big investors, no media, last about 2 weeks; major cities.  Can discuss business prospects, but only orally; can expand the prospectus but not differ from prospectus  Lead underwriter gets indication of interest  Final prospectus is printed, distributed for investors  Investors subscribe to stock at an offering price  After market closes, day before public trading (IPO declared effective)  List of buy/sell orders called the book  Difference between offering price and syndicate price about 7 to 8% (gross spread) – split between broker and underwriter

6. IPO process  6 to 8 weeks before SEC registration  Issue Red Herring to see interest (filed with SEC) – no price or size  Called Red Herring because of statements outlined in “ RED ”  Hold All-hands meeting, for IPO team and lead underwriter to decide responsibilities  Start developing final prospectus  SEC Registration  Filing of S-1 documents and prospectus  SEC imposes quiet period (until 25 days after IPO)  SEC reviews documents  Form syndicate  Lead underwrite forms group of underwriters to help sell deal, syndicate members are allocated shares to sell (best-effort or bought deal/firm commitment)

7. IPO process  Market opens, stock trades  Lead underwriter responsible for smooth trading  Can support stock, become market maker (SEC rules)  Research: Over 50% of trading volume for first couple months  Research: Buy back stock after trading (4% to 22%) – Why?  Impose penalty bids on brokers for flipping  IPO declared final (completion) 5 to 7 days after market debut.  Quiet Period Ends (25 days after trading)  Press and brokers can start covering stock  New information can be issued by firm  Lock-up Period Ends (180 days after trading)  Insiders can start selling stock  Piggyback registration

8. Some issues of IPO  IPO underpring  Scale of IPO and stock structure  Mechanism selecting of selling

9. IPO underpring 信息不对称 与 IPO 折价 投资者之间 的信息不对称 赢家的诅咒 投资者与 发行公司的信息 不对称 投资者的 信息优势 发行公司 的信息优势 认购风潮

10. 基本框架 现金流量价值 IPO 折价的目的 规避外部 股权介入 优先分配给 中小投资者 吸引外部股权介入 监督提升公司价值 优先分配给 机构投资者 私人控制利益

11. Biais and Faugerson- Crouzet Biais, Bosscarts and Rochet 信息 结构 外部人中的机构投资者有 私人信息 承销商与机构投 资者有私人信息 承销 机制 公开 申购 单一价 格竞拍 Mise en Vente 单一价 格竞拍 Mise en Vente 价格发 现功能 弱中好好弱

12. The Winner’s Curse Problem and IPO Underpricing  Firm A is planning to go public by selling 2,000 shares.  The true value of Firm A shares is either $8 or $12 with equal probabilities.  Therefore, the expected price of the shares is $8 * (1/2) + $12 * (1/2) = $10.  Let’s suppose that the IPO offer price is set at the $10 expected price …  There are two groups of investors planning to subscribe for the IPO:  Informed investors: Learn the true value of the shares before the IPO and subscribe accordingly:  If they learn that the true price is $12, informed investors subscribe 2,000 shares.  If they learn that the true price is $8, informed investors subscribe ZERO shares.  Uninformed investors: Don’t know the true price but know the expected price. Subscribe 2,000 shares.

13. The Winner’s Curse Problem and IPO Underpricing Now, let’s see the contingent payoff diagram with $10 offer price and 2,000 shares sold. There is obviously a wealth transfer from uninformed investors to informed investors. Uninformed investors who are aware of this problem will be unwilling to subscribe to the IPO unless the IPO is underpriced (the price is set somewhere below $10 where the expected profits to uninformed will be $0.) Prob.OFFERUninformedInformed 1/2 True price = $12 Offer price = $10 Receives 1,000 shares Profits = $2,000 Receives 1,000 shares Profits = $2,000 1/2 True price = $8 Offer price = $10 Receives 2,000 shares Profits = - $4,000 Receives 0 shares Profits = $0 Exp.E(profit) = -$1,000 = 0.5*2000 + 0.5*-4000 E(profit) = $1,000 = 0.5*2000 + 0.5*0

14. The Winner’s Curse Problem and IPO Underpricing  So, the question is what offer price do issuing firms set to make sure that the expected payoff to the uninformed will be $0 ? The offer price that will induce the uninformed to subscribe is calculated as follows: (1/2) * (1,000) * ($12 – OP) + (1/2) * (2,000) * ($8 – OP) = $0 $6,000 – 500 * OP + $8,000 – 1,000 * OP = $0 $14,000 = 1,500 * OP OP = $9.33 Why do issuers like to attract uninformed investors to subscribe? Because the existence of uninformed investors reduce the likelihood that a fixed price offer fails.

15. A case analysis: Google’s IPO Strategy  Outline  Google’s Background & Financials  Traditional IPOs  Google’s IPO Strategy  Dutch Auction  Conclusion

16. A case analysis: Google’s IPO Strategy  Google’s Background  Founded in 1998 by Stanford University students Larry Page (31) and Sergey Brin (30)  Started in a garage, 3 people  Now employs more than 2,200  Its search algorithm out-powers all rivals  Its name has become synonymous with Internet search  2 Main sources of revenue:  Giving advertisers the chance to display links to their sites  Providing Google search capability on other Web sites  Main competition: Yahoo and Microsoft  Factoid: the original name of Google was BackRub

17. A case analysis: Google’s IPO Strategy  Google Financials: Pre-IPO  Estimated Value before going public: $15M - $20M  Estimated Annual Revenue - $500M - $1B  Generates 95 percent of its revenue from advertising.  Estimated Profits - $150M - $300M  IPO could generate $4B  Had an audience of 60 million unique visitors, or 40 percent of all U.S. Internet users.

18. Income Statement of Goole

19. A case analysis: Google’s IPO Strategy  Traditional IPO  Company chooses an array of investment banks – led by one or two lead managers  Investment bank sets price  Bank sells to investors (Fidelity, wealthy individuals)  Prices are usually set low to ensure a big first day run for investment banks and their clients  Investors resell to public (typically at a higher price)

20. A case analysis: Google’s IPO Strategy  Technical Industry Background of IPOs  During the boom years of the 1990s, 400 companies went public each year  In 2003, only 69 companies completed IPOs(4 of which were dot-coms). This is the fewest since the 1970s  Weak market in 2004

21. A case analysis: Google’s IPO Strategy  Google’s IPO Strategy  In April 2004, Google announced plans to make its stock available via Dutch Auction  Underwriters  Morgan Stanley and Credit Suisse First Boston  Eighth largest IPO in history  E-mailed the selected bidders their price range  Defied conventional wisdom by choosing to go public in August, when the IPO market typically slows

22. A case analysis: Google’s IPO Strategy  Google estimated the price of its shares at well above $100 at a time average IPOs commanded far less  Predicted share price  Between $108 and $135 each  Class A and Class B common stock  Class A will have 10 votes per share; Class B will have 1 vote per share  Founders did not want to lose control

23. A case analysis: Google’s IPO Strategy  Google’s Decision: The Dutch Auction  Online auction  Investors bid on an IPO before it goes public  Benefits: in theory a fair market price is set and the company reaps more cash  Sets price on demand  Investment bankers do not set the price  Bankers do not control which investors get in. Equal opportunity for every level of investor.  Get sold directly to the public – cuts out the middle man

24. A case analysis: Google’s IPO Strategy  Aug 13, 2004  No IPO  Delayed a week because of logistics details. Couldn ’ t enter everybody in the auction system.  Morgan Stanley - “ This is all new to us, but we just hit a speedbump ”  August 18, 2004  Google stock (GOOG) opens at $100.01, after being priced at $85.00 ， lower than original ($108 - $135)  shares offered: 19.6 million ， Much less than original (25.7 million)

25. A case analysis: Google’s IPO Strategy  Was Google’s IPO strategy successful?  Concerns leading up to the IPO  Google to issue 2.7 million shares to Yahoo! Due to settlement over a patent issue  Management may have broken securities laws in 18 states by neglecting to register stock previously distributed to its employees  No explicit growth plans outlined to SEC  Overpriced stock in a weak market

26. A case analysis: Google’s IPO Strategy  Success  Pricing did in fact become transparent  Google remained a Good IPO in a Bad Market  Opened the door for similar-sized companies to consider using the Dutch Auction Method  Failure  Google left money on the table  It scared off retail investors with a high price tag and annoyed Wall Street  Final auction price fell well below the initial price range  Lower-than-expected price for shares raised fresh doubts about the auction process