From Traditional to Trendy: The Types of IPOs

December 06, 2023

Changing market dynamics and the advent of innovative financial strategies have altered the landscape of initial public offerings, and in today’s world, the avenues for going public are no longer contained within the traditional IPO framework (though this is still the most common method).

This article aims to provide a high-level overview of the different types of IPOs companies are now beginning to explore, and for those that stick around till the end, we’ll also be discussing a key strategic consideration that pre-IPO companies should keep in mind when preparing for life as a public company. This is a high-level overview of an increasingly complex and nuanced topic, and for those requiring deeper insight on IPOs and equity compensation, we highly recommend that you check out the NASPP’s “Equity Compensation Fundamentals – Private Companies” course.

The Types of IPOs

Alright, so let’s begin by exploring the different types of IPOs because In the past, and I mean even just five years ago, there was really only one type of initial public offering. Now, outside of the traditional way of doing things, we have companies beginning to explore the possibility of direct public offerings and SPAC transactions.

Traditional IPO

The traditional way of doing things typically involved several key steps. Initially, the company intending to go public would partner with investment banks, who would act as underwriters. These underwriters assess the value of the company and its shares, thereby determining its initial offering price. They would also take on the risk of buying the shares from the company and selling them to the public. The underwriting banks, along with the company's management team, would then embark on an IPO roadshow.

This roadshow is essentially a marketing campaign aimed at generating interest among potential investors, particularly institutional ones. During this phase, the company's value proposition, financial health, and future growth prospects are presented to potential investors. The goal is to build an order book and gauge the market demand for the company's shares. This traditional approach offers the benefits of expert guidance and market expertise from the underwriters, but also involves significant costs and regulatory requirements.

DPO – Direct Public Offering

Now, a direct public offering differs from the traditional IPO by avoiding the underwriting process entirely. Instead, the company directly lists its stock with a national securities exchange (or the over-the-counter markets), so that existing shareholders, which often include company founders, management, and other employees, can sell their stock in these markets. In many cases, the primary purpose of the DPO is to provide liquidity to existing shareholders; no new shares are issued as a result of the listing and the company does not raise any capital.

DPOs can be particularly appealing for well-known, established companies with strong customer bases, as they can leverage their existing reputation to attract investors directly. This approach also provides an opportunity for all classes of investors, not just institutional ones, to participate in the offering from the outset. Moreover, DPOs can be more cost-effective for the issuing company, as they eliminate underwriting fees. However, because they lack the marketing and price stabilization typically provided by underwriting banks, DPOs might initially face more market volatility.

DPOs are still not the most common type of IPO, but for those interested in learning more, this article by TD Ameritrade is a great place to start.

SPAC Transactions

Lastly, we have SPAC transactions, which have emerged as an interesting alternative to traditional IPOs and direct public offerings. SPAC, standing for special purpose acquisition company, is essentially a shell corporation specifically created for the purpose of acquiring a private company, thereby making it public. This process begins with the SPAC raising capital through its own IPO, wherein it collects funds and places them in a trust. This acquisition or merger process allows the target private company to become publicly traded without going through the extensive and often rigorous process of a traditional IPO.

SPAC transactions offer a faster, though sometimes riskier, route to the public market. The management team of the SPAC, including its sponsors and advisors, play a crucial role in identifying and acquiring the target company. Notably, SPAC transactions have gained traction in recent years due to providing an alternative pathway for companies wishing to go public, as they can potentially offer more certainty in pricing and deal terms when compared to traditional IPOs.

This article by PWC offers further insight into why SPAC transactions have become an intriguing prospect for some companies.

A Key Consideration for Equity Plans

Okay, so now for the promised strategic consideration companies should make before going public, as aside from deciding which type of IPO might be best for you, there are quite a few things that need to be discussed in order to ensure a smooth transition from a private company to a public one, and one of those items is around the potential adoption of new equity plans and/or the modification of existing ones.

While still private, you have the flexibility to make decisions without public company shareholder approval. During this period, an emphasis on discussions around the creation or modification of existing plans to allow as much flexibility as possible should be had, as this will be imperative for future efficiency and speed, and one modification that should be discussed is the potential adoption of an evergreen provision.

Evergreen Provisions

Publicly available information can be rather varied, as some sources have stated that as few as 60% of companies have adopted an evergreen provision in recent years before going public, while others have stated that as many as 70% have done so pre-IPO. Regardless, the sentiment remains the same: a good portion of pre-IPO companies have considered this to be an important step before going public. But why?

Well, you see, an evergreen provision is a mechanism that allows a company to automatically add a specified number of shares to its stock plan annually without needing to obtain shareholder approval each time. This addition of shares is predetermined and included in the terms of the plan, which shareholders approve in advance when the plan is initially submitted for a vote. This provision ensures a consistent and sustainable supply of shares for employee compensation, aiding in maintaining competitive incentive programs and attracting or retaining talent.

However, most proxy advisors and institutional investors view evergreen provisions unfavorably because they allow the plan to continue for up to ten years without additional shareholder approval. This sentiment can make it rather difficult for an existing public company to obtain enough support from shareholders to approve a plan that calls for an evergreen provision. For this very reason, we encourage most companies to at least humor this discussion during the pre-IPO process.

Conclusion

The IPO landscape has evolved in recent years, offering pre-IPO companies the flexibility to choose which route may best align with their situation. With the emergence of alternatives such as DPOs or SPAC transactions, companies no longer must go public via the traditional underwritten IPO. Who knows what other unique developments may occur in the coming years? Regardless of the type of IPO your company may decide to undertake, there are always going to be a plethora of strategic considerations that must be taken into account during the pre-IPO process.

And for this reason, we encourage readers to explore module seven of the NASPP’s “Equity Compensation Fundamentals – Private Companies” course, where industry experts offer invaluable insights and guidance, for those preparing to become a public entity.

By Jason Mann
Content Director

NASPP