Question

Hello, when a public is about to go public and they are determining the IPO, the gol is of the firm is to get as much cash as possible. Considering the Dutch auction or the traditional underwriters method:

a) which one would be better to focus on getting most cash and raising more cash?

b) is there a particular way to know the optimal size of the IPO?

c) What are the advantages of increasing the size of the IPO? and the disadvantages?

d) When a firm has an employee stock purchase plan, and the company is going public; what employees should do? sell their share in the IPO at the offering price or retain their stock and sell it after the firm goes public? What suggestion would you do to the employees and why?

Answer 1

A Dutch Auction is a technique of issuing shares wherein the entity opens an account with a merchant banker and through it, offers the prospective buyers its shares at a predetermined price (say $50). After recording the number of bids received at this level of price, the price is dropped to know how many more shares get applied for (say $48).

After the bids finally stop pouring in, the merchant banker checks the price level at which maximum bids were received to add maximum share subscriptions. That price is finalised for share issue and the applicants in that range are asked to pay the application money for the number of shares they applied for.

Traditional underwriting is a technique of issuing shares wherein the entity determines the number of shares to be issued and the issue price on its own and offers them to public through stock exchange. Any shortfall in the applications is met by the underwriter within a prescribed time frame. This ensures the entity that all its shares that it offers would get subscribed to.

(a). Dutch Auction can get the entity more cash as it empowers the buyers to control the price of shares in the auction. They are able to subscribe to as many shares as they want at a price that they find suitable. Because of these perks, more investors are attracted to such reverse auction practices.

(b). There is no way of determining the optimal size of an IPO. The company should carefully analyze its financing needs for prospective capital and operational expenditure. If excess cash is raised through IPO, the same should be invested diligently to earn enough to cover agency costs of cash handling.

(c). The advantages of increasing the size of IPO are :-

Adequate Liquidity : Enough cash will ensure that the existing operational and capital expenditure needs are met on time.

Expansion Planning : The company can also plan an expansion into new product line or market with excess funds or use the funds to design a new sales and marketing campaign.

Income generation : The company can invest the excess funds in various capital market and money market instruments to book income.

The disadvantages of increasing the size of IPO are :-

Carelessness among managers : The excess funds in the entity can jeopardize with innovation and diligence of the managers. They may become lethargic, knowing that their cash needs would be easily met in the hour of need.

Agency Costs : The agency costs of cash handling may also spike.

(d). Employee Stock Purchase Plans of the company ususally offer the shares to the employees at a price lower than at what they are being offered in IPO. So ideally, the employees must hold the shares at the time of IPO and sell them later at higher price on exchange.