Key Takeaways
- IPO (Initial Public Offering) is a company's first sale of stock to the public.
- Registration statement (S-1) must be filed with the SEC before going public.
- The cooling-off period (20+ days) is the SEC review period before effectiveness.
- Firm commitment: Underwriter BUYS all shares and bears the risk of unsold shares.
- Best efforts: Underwriter only acts as agent; ISSUER bears the risk.
- All-or-none: Must sell ALL shares or the entire offering is cancelled.
- SPACs are 'blank check companies' that raise money to acquire private companies.
- Rule 144 governs the resale of restricted and control securities.
Public Offerings and IPOs
When companies want to raise capital by selling securities to the public, they conduct public offerings. Understanding the process and participants is essential for the Series 66 exam.
Types of Offerings
| Type | Description | Example |
|---|---|---|
| IPO (Initial Public Offering) | First time company sells stock to public | Private company going public |
| Secondary Offering | Current shareholders selling their shares | Founder selling stake |
| Follow-On Offering | Company issues additional shares | Dilutes existing shareholders |
| Shelf Registration | Pre-registered shares sold over time | SEC Rule 415 |
Primary vs. Secondary Offerings
| Feature | Primary Offering | Secondary Offering |
|---|---|---|
| Seller | The company | Existing shareholders |
| Proceeds | Go to company | Go to selling shareholders |
| Dilution | Dilutes existing shares | No dilution |
| Purpose | Raise capital | Provide liquidity |
The IPO Process
Step-by-Step Process
| Step | Action | Key Details |
|---|---|---|
| 1. Select Underwriter | Hire investment bank | Usually competitive process |
| 2. Due Diligence | Verify all information | Legal, financial, business review |
| 3. File Registration | Submit S-1 to SEC | Prospectus included |
| 4. SEC Review | Cooling-off period | Minimum 20 days |
| 5. Roadshow | Market to investors | Build book of demand |
| 6. Price Setting | Final offer price | Night before trading |
| 7. Trading Begins | Stock goes live | Listed on exchange |
Registration Statement (S-1)
The registration statement contains:
-
Prospectus (Part I): Distributed to investors
- Business description
- Risk factors
- Financial statements
- Use of proceeds
- Management information
-
Part II: Additional information for SEC
- Expenses
- Exhibits
- Undertakings
The Cooling-Off Period
The cooling-off period is the minimum 20-day SEC review period after filing the registration statement.
| What CAN Be Done | What CANNOT Be Done |
|---|---|
| Distribute preliminary prospectus (red herring) | SELL securities |
| Take indications of interest | Accept money |
| Conduct roadshows | Make binding commitments |
| Prepare sales materials | Guarantee allocations |
Exam Tip: During the cooling-off period, the underwriter can take "indications of interest" but cannot make SALES or accept MONEY.
Underwriting Methods
Firm Commitment Underwriting
In a firm commitment, the underwriter purchases ALL shares from the issuer at a discounted price and resells them to the public.
| Feature | Details |
|---|---|
| Risk Bearer | Underwriter |
| Commitment | Buys all shares |
| Spread | Difference between purchase and sale price |
| Best For | High-quality, established companies |
| Guarantee | Issuer guaranteed to receive proceeds |
Example: Company issues 1 million shares at $20. Underwriter buys all at $19 (5% discount), resells to public at $20, earning $1 million spread.
Best Efforts Underwriting
In a best efforts arrangement, the underwriter acts as an agent and makes no guarantee of sale.
| Feature | Details |
|---|---|
| Risk Bearer | Issuer |
| Commitment | Sells what it can |
| Role | Agent, not principal |
| Best For | Smaller, riskier companies |
| Guarantee | None - unsold shares not purchased |
All-or-None Offerings
A type of best efforts where 100% of the shares must be sold or the entire offering is cancelled.
| Feature | Details |
|---|---|
| Condition | All shares must be sold |
| If Not Met | Offering cancelled, money returned |
| Proceeds | Held in escrow until completion |
| Rule | SEC Rule 10b-9 governs |
Underwriting Comparison Summary
| Method | Risk Bearer | Guarantee | Proceeds |
|---|---|---|---|
| Firm Commitment | Underwriter | Yes, all shares | Immediate |
| Best Efforts | Issuer | No guarantee | Only what sells |
| All-or-None | Issuer | Must sell all | All or nothing |
| Mini-Max | Issuer | Minimum threshold | Minimum or nothing |
Exam Tip: In FIRM commitment, the underwriter takes the risk. In BEST EFFORTS, the issuer takes the risk. Remember: Firm = underwriter Firmly commits.
SPACs (Special Purpose Acquisition Companies)
SPACs are "blank check companies" that raise capital through an IPO with the sole purpose of acquiring a private company.
SPAC Structure
| Phase | What Happens |
|---|---|
| Formation | Sponsors create shell company |
| IPO | SPAC goes public, raises funds |
| Search | 18-24 months to find target |
| Announcement | De-SPAC merger announced |
| Vote | Shareholders approve merger |
| Merger | Target becomes public company |
Key SPAC Features
| Feature | Details |
|---|---|
| Trust Account | IPO proceeds held in trust |
| Redemption Rights | Investors can redeem at ~$10/share |
| Warrants | Often included with units |
| Time Limit | Typically 18-24 months |
| If No Deal | Money returned to investors |
SPAC Risks
| Risk | Description |
|---|---|
| No target known | Investing blind |
| Sponsor dilution | Sponsors get 20% "promote" |
| Redemptions | May reduce deal proceeds |
| Quality concerns | May acquire weaker companies |
Restricted and Control Securities
Restricted Stock
Restricted stock is acquired in unregistered, private sales (e.g., private placements, employee compensation).
| Source | Example |
|---|---|
| Private Placement | Regulation D offerings |
| Compensation | Employee stock grants |
| Merger Consideration | Stock received in M&A |
Control Stock
Control stock is owned by affiliates (insiders) of the company - officers, directors, or 10%+ shareholders.
Rule 144: Safe Harbor for Resale
Rule 144 provides a safe harbor for selling restricted and control securities.
| Requirement | Restricted Stock | Control Stock |
|---|---|---|
| Holding Period | 6 months (reporting) / 1 year (non-reporting) | None |
| Current Information | Required | Required |
| Volume Limit | Required | Required |
| Manner of Sale | Required | Required |
| Form 144 | Required if >5,000 shares or $50,000 | Required if >5,000 shares or $50,000 |
Rule 144 Volume Limits
| Calculation | Formula |
|---|---|
| Greater of: | 1% of outstanding shares OR |
| Average weekly trading volume (4 weeks) | |
| Time Period | Rolling 90-day period |
Exam Tip: Rule 144 has a 6-month holding period for RESTRICTED stock of REPORTING companies. Control securities have no holding period but are subject to volume limits.
In a firm commitment underwriting, who bears the risk if all shares are not sold?
During the cooling-off period, an underwriter may:
A SPAC (Special Purpose Acquisition Company) is best described as:
Under Rule 144, the holding period for restricted securities of a reporting company is:
4.1 Mutual Funds
Chapter 4: Pooled Investments