After the presentations, the company will reward the winning contestants with an opportunity to manage the IPO. If the company selects more than one investment bank, one will be designated as the lead underwriter while the others will be comanagers.

The managing underwriters may underwrite the IPO on either a firm commitment or best efforts basis. In a firm commitment offering, the underwriters will purchase the shares at a discount (of usually 7%) and resell them for the full public offering price to institutional and individual investors. In contrast, a best efforts offering means that the underwriters are only committing their best efforts to sell the shares.

Most reputable investment banks will underwrite an IPO on a firm commitment basis. If an IPO is being underwritten on a best efforts basis, it should serve as a warning signal to both the company and its potential investors. After all, how enticing will a company's shares appear if its investment bank is unwilling to shoulder the risk of holding the shares, especially when purchased at a discount? Some sample underwriter discounts are listed below.

To help distribute the shares, the managing underwriters may form a syndicate composed of other investment banks. This serves two purposes. First, the underwriters may expand the marketing of the company's shares through other investment banks. Second, the managing underwriters may reduce their risks by allocating shares to other investment banks. The syndicate members may agree to participate by either purchasing and reselling the shares, or just marketing the shares to their institutional and individual clients.

Other Players

Besides the underwriters, a number of other key players will assist in the IPO process. This group includes the legal counsel, the auditors, the printer, the transfer agent, and the bank note company.

Lawyers

The company and the underwriters will each be represented by legal counsel. Internally, company counsel will review the company's documents, records, and business to identify potential legal problems and make required disclosures on the prospectus.

Example - Goldman Sachs Registration Statement

Legal Matters

          We are involved in a number of judicial, regulatory, and arbitrationproceedings (including those described below) concerning matters arising in connection with the conduct of our businesses. We believe, based on currently available information, that the results of such proceedings, in the aggregate, will not have a material adverse effect on our financial condition, but might be material to our operating results for any particular period, depending, in part, upon the operating results for such period.

Underwriters Antitrust Litigation

          GS&Co. is one of numerous financial service companies that have been named as defendants in certain purported class actions brought in New York federal court by purchasers of securities in public offerings, who claim that the defendants engaged in conspiracies in violation of federal antitrust laws in connection with these offerings. The plaintiffs in each instance seek treble damages as well as injunctive relief. One of the actions, which was commenced in August 1998, alleges that the defendants have conspired to discourage or restrict the resale of securities for a period after the offerings, including by imposing "penalty bids." Defendants moved to dismiss the complaint in November 1998. The plaintiffs amended their complaint in February 1999, modifying their claims in various ways, including limiting the proposed class to retail purchasers of public offerings. Several other actions, commenced in November and December 1998, allege that the defendants, many of whom are also named in the other action discussed above, have conspired to fix at 7% the discount that underwriting syndicates receive from issuers of shares in certain offerings.

Company counsel will also coordinate the drafting of the registration statement, guide it through the SEC review process, help negotiate the underwriting agreement, and coordinate with the other participants.

Externally, legal counsel for the underwriters will represent them in the registration statement drafting and due diligence process, as well as in the preparation of the underwriting agreement. They will also coordinate document reviews with the National Association of Securities Dealers (NASD) and any state securities authorities.

Auditors

The company auditors will help the chief financial officer address accounting issues and prepare the financial disclosures required in the prospectus. They will also address accounting issues raised by the SEC and prepare the conform letters, which summarize their verification procedures for certain financial information in the prospectus. The underwriters receive these letters when the offering becomes effective and again at closing.

To coordinate the offering, company counsel, the underwriters, the underwriters' legal counsel, and the auditors will hold an all-hands meeting early on. At this session, the underwriters will assign the tasks for which each participant is reponsible and distribute a schedule outlining when these tasks must be completed.

Printers

Finally, the financial printer will print the prospectus, the transfer agent will issue and transfer the company's shares and coordinate shareholder mailings, and the bank note company will design and print the new stock certificates.

How to choose a qualified IPO underwriter

An underwriter (investment banker) is responsible for positioning, pricing and marketing your initial public offering (IPO) and therefore is critical to its ultimate success. Your responsibility as a IPO candidate should be to understand the various terms, commitments and contracts used by underwriters.

Before you commit to a specific underwriter with a letter of intent, do your homework and check out your future partner. Although a letter of intent does not necessarily bind either party, it can prevent you from dealing with other underwriters for a stipulated period of time. Do not commit to such a letter until you are confident in your choice of underwriting partners.

The letter of intent is the first of several documents into which you will enter with your underwriter. Though it is a signed document, it is not binding beyond the narrow expense provisions it delineates.

The second document, which is binding, is the underwriting agreement. Under normal circumstances, it is not signed until within 24 hours of the expected effective date of the registration statement. By this time the underwriter has received purchase commitments or indications that are commonly well in excess of the offering size.

In between these two documents, your company will incur substantial expenses with no assurance that the offering will take place. This is not an idle observation. Stories about IPOs reaching the 11th hour -- only to be withdrawn or delayed because market conditions have changed or the underwriter has reconsidered -- do exist.

Underwriting agreements come in two basic types: "firm commitment" and "best efforts."

Under a firm-commitment agreement, the underwriters pledge to buy all the stock offered in the IPO and resell it to the public. This arrangement offers the company the most security because the owners know they will receive the full sales price of the issue. However, until the underwriter and the company establish the pricing and execute the underwriting agreement, the only commitment on the line is the underwriter's reputation.

In contrast, under a best-efforts commitment, the underwriter, using its best efforts to sell the stock, is under no obligation to purchase the stock should part of the issue remain unsold. An underwriter who considers the issue "risky" may prefer this type of agreement to shift the risk to the company.

There are variations to these two basic agreements. An "all-or-none" commitment is a modification of the best-efforts agreement: All of the stock must be sold by the underwriter or the entire issue is canceled (at considerable cost to the company). In a partial all-or-none agreement, the underwriter requires sale of a specified portion of the issue (typically two-thirds) for the best efforts to remain in effect on the remainder of the issue.

If possible, avoid best-efforts underwriting, as these can be negatively perceived.

Most IPOs are firm-commitment underwritings. If all the underwriters you evaluate are only willing to proceed with a best-efforts underwriting, you may wish to reconsider other financing alternatives, as this may be an indication your company is really not ready to go public.

As part of the underwriting agreement, underwriters may request a lock-up of the insiders' stock for a period of several months to several years after an IPO. Even though sales of such shares may be somewhat limited due to other restrictions, it is the underwriter's goal to maintain a strong aftermarket by avoiding insider sales or bailouts.

After all the work has been done and your IPO has succeeded, there's still more work for your underwriter to complete. Post-IPO commitments are critically important to your company.

Competent aftermarket support entails providing research data on your company and its competitors to the financial community, as well as financial advice. A quality road show should leave an unsatisfied demand level for your stock that will further help the aftermarket support and performance of your stock.

IPO pricing when underwriters are venture capital investors in issuers and test three hypotheses concerning the effects of underwriter share ownership on the IPO underwriting and pricing processes. We find that venture investments by underwriters significantly reduce IPO underpricing; and the result is stronger for lead underwriters. This evidence is consistent with both underwriter certification and improved underwriter alignment of interests with issuers. The fall in underpricing is substantially greater when there is greater uncertainty about IPO valuation, which further supports the underwriter certification effect. Controlling for endogeneity effects does not change our conclusions. Finally, lead underwriter venture investment in IPO issuers also reduces underwriter gross spreads. Overall, the evidence is consistent with an underwriter certification effect and to a lesser degree an underwriter-issuer alignment of interest effect and inconsistent with an IPO conflict of interest effect.

IPO Basics: Conclusion

Let's review the basics of an IPO:

• An initial public offering (IPO) is the first sale of stock by a company to the public.
• Broadly speaking, companies are either private or public. Going public means a company is switching from private ownership to public ownership.
• Going public raises cash and provides many benefits for a company.
• The dotcom boom lowered the bar for companies to do an IPO. Many startups went public without any profits and little more than a business plan.
• Getting in on a hot IPO is very difficult, if not impossible.
• The process of underwriting involves raising money from investors by issuing new securities.
• Companies hire investment banks to underwrite an IPO.
• The road to an IPO consists mainly of putting together the formal documents for the Securities and Exchange Commission (SEC) and selling the issue to institutional clients.
• The only way for you to get shares in an IPO is to have a frequently traded account with one of the investment banks in the underwriting syndicate.
• An IPO company is difficult to analyze because there isn't a lot of historical info.
• Lock-up periods prevent insiders from selling their shares for a certain period of time. The end of the lockup period can put strong downward pressure on a stock.
• Flipping may get you blacklisted from future offerings.
• Road shows and red herrings are marketing events meant to get as much attention as possible. Don't get sucked in by the hype.
• A tracking stock is created when a company spins off one of its divisions into a separate entity through an IPO.
• Don't consider tracking stocks to be the same as a normal IPO, as you are essentially a second-class shareholder.