An underwritten Initial Public Offering is the most widely known method for a company to become publicly-held. The SEC’s IPO rules require issuers to file a registration statement and preliminary prospectus (also know as a red herring) with the SEC. This Registration statement must contain, among other things, the following information:
• A description of the issuer's capitalization and the use of proceeds;
• A description of the issuer's business and properties;
• A description of the risk factors associated with the business;
• A description of the issuer's directors, officers and promoters, together a 5 year business history on each such person;
• A description of the securities held by directors, officers and principal shareholders;
• A description of any material legal proceedings;
• Audited financial statements of the issuer;
• Copies of certain corporate documents and all material contracts.
Once the registration statement and preliminary prospectus are filed with the SEC, a 60 to 90 day review period begins. During the review period the proposed new issue may be discussed with potential buyers, but brokers are prohibited from distributing any offering materials other than the preliminary prospectus. Testing receptivity to the proposed issue is known as gathering "indications of interest." An indication of interest does not obligate or bind the customer to purchase the issue when it becomes available, since all sales are prohibited until the security has cleared registration.
A final prospectus is prepared and distributed when the SEC completes its review of registration statement and issues an order of effectiveness. The final prospectus contains all of the information contained in the preliminary prospectus and any amendments thereto, as well as the final price of the issue, and the underwriting spread. The clearing of a security for distribution does not indicate that the SEC approves of the issue. The SEC ensures only that all necessary information has been filed, but does not attest to the accuracy of the information, nor does it pass judgment on the investment merit of the issue. Any representation that the SEC has approved of the issue is a violation of federal law.
One of the most confusing phrases in the securities industry is the term "firm underwriting." In the context of an initial public offering, the term merely means that the underwriters have a legal obligation to close on the offering if the commitment is not withdrawn before the registration statement becomes effective. Notwithstanding the existence of a letter of intent for a firm underwriting, however, the underwriters are under no obligation to go forward with a proposed offering and generally have the unrestricted right to back out of the offering at any time before the registration statement is declared effective by the SEC. As a result, it is not uncommon for a company to spend hundreds of thousands of dollars on an IPO only to have the offering canceled by the underwriters as the effective day of the offering approaches. Going public through an IPO is an all or none proposition. If an issuer is successful, the company is both public and capitalized. If the underwriting is unsuccessful, the issuer is neither public nor capitalized, and out a sizable sum of money for the costs of the failed offering.