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Source: SF-gate.com


Everyone's favorite search engine -- Google -- is about to go public, meaning the firm's shares will trade in a public market for the first time. The initial public offering, which could raise as much as $2.7 billion, has generated excitement in the previously moribund market for IPOs. The firm's popularity and its anticipated success on Wall Street have many average investors interested in buying in.

But what does the average person really know about public stock offerings? Not much. For instance, most people think the IPO occurs the day the stock begins trading publicly. In fact, the actual IPO occurs the day before. That's when the firm hands over a preordained number of shares to the investment banking community, which sets a price for the shares, and then hands the company a big bag of money. That's how the company raises money.

It gets even more confusing when you try to figure out how investors get to buy the shares. In Google's case, the company has chosen a relatively untested auction method for allocating shares of its offering. Google says it hopes the auction will create a more realistic valuation for the firm and also democratize the share allocation process, allowing average investors to swim with the biggest fish in banking.


1 A private company needs money to expand its business, perhaps to open a new sales office, hire more engineers or build a manufacturing plant.

2 The money needed is more than the company's existing investors are willing or able to provide, so the firm's board of directors decides to sell a percentage of the company's privately held shares to public investors.

3 The board hires investment bankers, which will help sell the shares to professional money managers. These money managers, or institutional investors, who often buy and sell stocks through the bank's trading desk, have the deep pockets and risk appetite required for IPO investing. One investment bank acts as the lead manager of the deal, while a few co-lead managers help sell the shares to their clients.

4 The company then files a document with federal securities regulators to register as a public company. The filing, called an S/1 and accessible to the public at www.sec.gov, gives potential investors the required details about the company's operations, finances, customers and rivals.

5 Regulators at the U.S. Securities and Exchange Commission then examine the document to ensure that it provides the information investors need. SEC staff will usually ask for some minor changes to the S/1 filing, or in some cases more substantive changes. For example, the SEC recently asked softwaremaker Salesforce.com Inc. to change how it accounted for sales commissions before it allowed its IPO to proceed. Once the SEC and the company agree to any changes, the company amends and refiles the document.

6 The amended document provides additional details about how many shares the company will sell and within what price range. Officially called a preliminary prospectus, the document is known in investment banking circles as a red herring because of the color of the print on its cover and because it serves as a warning to investors that the document may not contain all the information about a company.

7 With red herring in hand, the company's investment bankers, along with its chief executive or chief financial officer, spend two to three weeks traveling to big cities like New York, Chicago and Boston to meet in private with money managers and other large investors. Known collectively as a road show, the meetings reveal how many shares investors are willing to buy and at what prices.

8 After the road show, the company's board of directors and its lead bankers set the IPO price. For IPOs with strong demand, it is usually the maximum price at which they think they can sell all of the IPO shares, minus a discount to guarantee that the shares rise on their first day of public trading, known as the pop. These first-day gains, often two-, three- and fourfold during the dot-com boom, are good for IPO investors but not necessarily for the company, which theoretically could have sold the shares at a higher price and therefore raised more money for itself.

9 After the price is set, on the day of the offering, the banks dole out the shares to their clients -- the big investors -- based on a percentage allocation of how many each client requested. In other words, they might get half the shares they asked for, or three-quarters, etc. The banks transfer the shares to the clients' accounts and deduct their cost. The proceeds from the sale are kept by the bank, which deducts its fees -- usually between 4 and 7 percent -- then gives the rest to the company going public. The company makes money only from this private sale, not from any public trading of the shares afterward.

10 The day after the IPO, the company's shares begin trading on the public markets. At this point, you can calculate a rough market valuation for the entire company. Simply put, you take the price that the public market settles on for any given day of trading, and then multiply that price by the total number of shares that exist for the company, both public and private. Once the firm is public, it's also possible to calculate how much the firm's early investors stand to gain. These folks, who include founders, executives, venture capitalists, etc., all invested in the company early on and were given private shares as their reward. Now that they can sell those shares on the public market, they can cash out on their early investment.


1 From the get-go, Google's motivation to go public is different from most companies. The firm says its fast-growing search business generates lots of cash, so it doesn't need the money to grow. The company doesn't give a specific reason for going public, although there are plenty of theories on why it's doing it now.

2 Many people think the popular search engine firm is going public because its main rivals, Yahoo and Microsoft, are getting a peek at Google's financial details for the first time. That's due to an obscure SEC regulation that forces Google to reveal its finances because so many of its employees receive stock options. It should be noted that the offering allows the company's founders, workers and venture capital backers to reap a huge financial windfall. Both reasons most likely played a role in Google's deciding to go public.

3 Instead of hiring investment bankers, Google is opting for an unusual auction model that will likely limit the fees it pays to bankers. The firm also spread the wealth around by choosing 30 different bankers.

4 Google files an S/1, but it was perhaps the most unique document the SEC has even seen. The founders wrote that they didn't need to go public and would not run the company to please Wall Street's short-term interests. That got people's attention.

5 This is the stage that the Google offering is in now. The company filed its S/1 document April 29 and is waiting to hear back from the SEC.

6 Depending on what the SEC asks for, Google will follow the rules and create its prospectus.

7 It's unclear whether Google will do any road show. Demand for its stock is so strong that it's unlikely the company will have difficulty selling its shares, which would eliminate the need for the sales meetings.

8 Investors who wish to bid on Google shares must open an account at one of the 30 banks and brokerage firms listed in its prospectus. They will be issued a unique bidder ID, which will be e-mailed (not mailed or faxed) to all auction participants only after they have accessed an electronic version of the company's preliminary prospectus. Once they receive their bidder ID, auction participants will be asked to indicate how many shares they wish to buy and at what price. Potential buyers can bid on as few as five shares, and there is no upper limit on how many shares bidders can ask for or how high they can bid, although Google said it will disqualify unusually high bids that it considers speculative.

9 After bids from all investors are compiled in a huge list, with the highest bid first, the bankers go down the list and allot IPO shares until they run out of shares. Along the way, the bank and the company reserve the right to distribute the shares as they see fit. In other words, not everyone will get the requested number of shares. Once all the available shares have been handed out, the bankers take and call that the clearing price. That's what the auction winners will pay for their shares no matter what they bid. Those who bid below that price get no shares. Finally, in a move more akin to a traditional IPO, Google's bankers can set the price the auction winners will pay at a small discount to the clearing price. This would ensure a first-day pop, or price surge for initial shareholders, when the stock begins trading.

10 Those who successfully bid will have the number of shares transferred into their account at the bank. The next day, when the shares begin trading on the public markets, they will be free to sell their shares or buy more in open trading. It should be noted that once the shares start trading publicly, anyone can buy Google's shares. The frenzy around getting in before the start of trading has a lot to do with the assumption that Google's shares will rocket upward. Of course, that assumption is partly speculation. Betting that a newly public firm's shares will appreciate is no sure thing.

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July. 12,  ISSUE #037

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