IPOs

Godfather Revisited Part II: Show Me The Money

You lead a double life. Student by day, kebab seller by night. Hey, it pays the bills.

 

In your second year, you incorporated Penultimate Kebabs, received the certificate of incorporation from the Companies House and launched straight into the world of doner and polystyrene boxes.

 

Financially, it’s been a tough year. You’ve bought a lot of textbooks. Equity and the Law of Trusts by Pettit. Equity & Trusts by Davies. You have no idea why you bought both. And Street on Torts. And Gray & Gray. Ad infinitum.

 

Anyway, the long and short of it is, you’re low on cash. And no bank will give you a loan. But you’ve heard about IPOs. That’s what the big boys do to get money right?

 

They have shareholders willing to pay for shares. And you have dead drunk customers hungry for kebabs. So you take your certificate of incorporation and tear it into 30 equal parts. Which can be pieced back nicely together. And you wait. Later that night, you proposition your first investor, the hungover biologist Bob, as he munches away at his chicken chips with curry. “Would you give me a hundred quid for a share in my kebab company? ”

 

*mumble mumble*

 
“It’s a good deal Bob. You get to make decisions, and every year I’ll invite you to the annual general meeting of Penultimate Kebabs. It’ll be held on my college lawns.”

 

*more mumbling in the style of Thorner v Major*

 
At last, the two of you seal the deal by shaking hands, one drunk on the thought of money and the other, just drunk. And that’s the basic idea of an IPO: raising money by offering someone a share in your company in exchange.

 
IPOs are usually classified under the “equity capital markets”, which are distinct from debt capital markets. Again, ChambersStudent does a really good formal introduction.

 
We’ll give you a simpler explanation here. Equity has many meanings, but for our purposes, it means a share in a company. The 30 slips of paper are a representation of that. Now imagine a bustling market. Money (capital) is exchanged for slips of paper (equity) in the market. And that’s basically what the equity capital markets are about.

 

Key Players – Dramatis Personae

 

Formal Definition In Our Own Words
Issuer Entity which issues shares in exchange for money. That’s you, the boss of Penultimate Kebab.
Investors/Future shareholders Individuals or corporations which pay a sum of money in exchange for shares in the issuer. There are many type of investors but the most commonly heard of are retail investors; ordinary individuals on the street. More unsuspecti— enterprising customers like Bob the biologist who are willing to buy shares in your kebab company.
Sponsors/Underwriters Entities which help the issuer to sell the shares. Usually investment banks.
 
Commercial point: why doesn’t the issuer sell the shares by itself?
 
*Also, note underwriters are often the sponsors but that’s not always the case.
Turns out you have an essay due the next day. So you outsource the job of selling your shares to Ari, the geography student who never seems to have exams but has a ton of friends, to do it for you. Ari gets a cut in return depending on how many shares he sells.
Lawyers Includes in house counsel for the issuer, counsel for the underwriters/sponsors and counsel for the issuer. Turns out the Council of Kebab sellers has regulations on what you must do when you sell shares to folks on the street. You hire Greg, a third year lawyer who doesn’t care about Finals, to check out the rules for you.
Share Registry A share registry tracks share movements, ensuring shareholders have the right amount of shares to their name at any point in time. This in turn ensures inter alia, that shareholders receive the right amount of dividends. You foresee that there will be many shareholders at any given time. Some may sell their shares. Once Bob recovers from his hangover, he will do his very best to fob his shares off on someone else. You hire Albert to help you keep track of who currently holds shares in Penultimate Kebab.
Brokerage A financial intermediary which holds shares on behalf of the shareholder for convenience. In the issuer’s records, these shares are held under the brokerage’s name, not the shareholder’s. After listing your kebab company, so many people are buying and selling shares that middlemen start popping up. Shareholders buy and sell shares through them, you don’t have to deal directly with them anymore. You’re a big boy now.
Financial Printers Companies which specialise in printing prospectuses and other documents, like SEC filings. Your trusty neighborhood bookstore equipped with a Xerox printer. They printed your advertising brochure for you when you first started selling shares. They also handle all the forms you need to submit to the Council of Kebab Sellers.
Auditors Firms responsible for ascertaining the financial health of the issuer, and for issuing Comfort Letters. These are opinions by auditors as to the financial health of the issuer for the interim period leading up to the IPO. Comfort Letters are given because it’s not the end of the financial year yet and no annual financial statement has been done up yet. Jan the micro finance society president helps make sure your account books tally. For a fee. He posts a notice on your van bearing his name. It says he thinks you’re not a fraud (so naturally, you must be financially sound).

 

Key Stages

 

Formal Definition Colloquial Definition
Kickoff Meeting Once the identity of the key parties are confirmed, everyone comes together to kick off the IPO listing process. Pub crawl with da boyz. Ari your salesman, your auditor Jan, and all the rest.
Due Diligence Lawyers from both sides conduct due diligence on the issuer company. For instance, they will check if the company is authorised by its Articles of Association to issue shares up to X amount. Greg checks up your history to see if you were sued by your customers in the past year. He also checks if you mortgaged your kebab van to the bank for money. Finally, he rummages through your pockets to make sure you’re not broke. That’s what he says anyway.
Application proof submission A draft of the prospectus is submitted to the stock exchange for vetting. Before you distribute brochures advertising your kebab company shares, you need the elders at the Council of Kebab Sellers to approve it.
Roadshow Investment banks help to take orders from interested clients. Ari makes his rounds in the neighborhood to hard sell your shares and take orders.
Listing Shares are allocated to investors and the stock is finally traded on the stock exchange. You get your money and your customers get shares in Penultimate Kebab. Wherever people gather in town, they buy and sell your company shares like board game trading cards.

 

The role of a lawyer.

 

What does a lawyer do in all of this? The answer depends on whether the lawyer is counsel for the issuer, sponsor or general counsel. As a potential firm trainee, you just need an understanding of what lawyers generally handle:
 

  1. Due diligence
  2. Prospectus
  3. Underwriting Agreement
  4. Share Subscription Agreement
  5. Printing Agreement

 
Pair this with the information available on ChambersStudent’s “What Lawyers Do” page to get a more comprehensive picture.

 

Sneak peek.

 

Stay tuned for our cartoon illustrated version of what IPOs are all about:

 
“This is a story about Winnie the Pooh, who as everyone knows, has a weakness for honey. Winnie is what we would call a rotund fellow. But don’t say that in front of him. Winnie also wears an undersized red top while neglecting to address the issue of what should be worn below. When he asks how he looks, you should simply produce a disarming smile with a light tinge of idiocy.

 
But Winnie is one to watch. Beneath his cherubic exterior lies the heart of a seasoned businessbear. Winnie, like many of his ursine kin before him (the most famous one being Teddy), has turned his passion into a booming career. Today, Pooh-Pooh Limited is well known for its premium honey products, supplied from five thousand acres of golden, glistening real estate, and prized by connoisseurs like the Goldilocks trio as well as the Paddington bear, who cannot wait to get their paws stuck in the jars.

 

Meanwhile, left paw on chin and right paw on belly, Winnie has been mulling over his next big move in a dark brooding tower of honey…”