When a company decides to conduct an Initial Public Offering (IPO) of stock, it is not making a cheap decision. The steps in the process, once the decision is made, cost money.
The underwriters are primarily involved with compliance issues, structuring the deal and pricing the new shares and later attempting to sell the stock. They get paid for this by getting a percentage, typically 8%-9% of the offering price.
Itʼs big money too.
Buckhorn Capital Investment reported in September, “the securities industry earned just under $6.6 billion in underwriting fees for both debt and equity.”
Thatʼs money that did not go to business operations through the IPO.
Add to this fact, the underwriting business is largely controlled by 10 firms. Merrill Lynch, Goldman Sachs and Lehman Brothers are the lead players.
IPO underwriter commissions and profits are therefore concentrated into a very few hands.
Investment bankers and underwriters can be the same. In the cases where they are identical, the profits go up even more and the income going directly to the IPO company is further reduced.
Consider the recent Facebook IPO as an example of how investment bankers can quickly make a ton of money on an IPO.
The Wall Street Journal reported on May 23, 2012 “Morgan Stanley and other underwriters have made a profit of about $100 million stabilizing Facebook Inc. stock since trading began on Friday, people familiar with the matter said.” The article further stated, “The bank would receive the money on top of millions of dollars in IPO fees, the people added.”
Because of the regulations involving an IPO and getting registered with a stock exchange, most companies hire attorneys. These firms have extensive experience in securities law and most are nearly as old as the New York Stock Exchange if not older.
Going right back to the Facebook IPO, Find Law reported on May 21, the social media paid $2.6 million to the law firm of Fenwick & West’s Silicon Valley office.
With each trade before an IPO stock reaches the public, the price has typically gone up to allow the seller to make a profit. This means the big investment banks and their giant-wallet institutional investors have bought the stock and sold it for a profit.
When the average person is able to buy the stock, they still have to go through a broker. Even trading only with very small trading fees can add up to serious money.
Again, more money that does not go into the coffers of the IPO business.
By the time the stock finally reaches the general public, the amount of money diverted from the IPO company into the hands of banks, traders and underwriters can be staggering, as much as 30 percent or more.
Putting a real value on those numbers, if an IPO sold stock worth $1,000 by the time the public could buy stock, the company would only have $700. In this case, $300 is a significant amount.
Ilan Moscovitz, senior analyst for the Motley Fool, reported the average markup in IPO stock from 1990 to 2009 was 22 percent amounting to $124 billion.
Think about what could happen if a company issued IPO stock direct to the public without any middlemen. In the first place, the company would get 100 percent of the money from investors. No commissions, no extra fees, no discounts. RThe company would get the money is needed.
Secondly, investors would pay the true value of the stock and not have to worry about add ons, fees and exorbitant commissions. Thirdly, the stranglehold the SEC and a handful of giant financial institutions have over the world of stocks and trading would be broken.
This would level the playing field in a true capitalistic form. There would be less government interference and far more “free market” rules governing the price of stocks.