Initial public offering (IPO)

Initial public offering definition

An initial public offering (IPO) refers to the first time a company sells shares publicly. It is a form of equity financing.

An initial public offering (IPO) takes place when a company offers itself up for public ownership by listing and selling its shares on a stock exchange.

A complex and highly regulated process, it requires support from specialists, such as accountants and lawyers.

Because it opens up ownership to everyone who is interested in the company and believes in its prospects, IPOs often turn out to be a lucrative proposition for the company’s pre-IPO owners.

What is an IPO and how does it work?

An IPO is the process of listing the company as an asset to be bought or sold on public markets. This process can take anywhere from six months to a year. In many cases, it offers an opportunity for company founders and private investors, such as venture capital funds or private equity investors, to sell their shares and earn a profit.

During the IPO process, the listing company will work with a team of professional service providers to:

  • audit the company’s financial statements and prepare them for regulatory review
  • set the company’s processes and procedures on a path consistent with the requirements of a public company
  • prepare a prospectus and work with regulators and public market exchanges to get the company’s listing approved
  • price the shares, build demand for the offering and ultimately list them on an exchange

What is an IPO company?

Companies may be ready for an IPO at different stages, depending on their industry, financial situation, liquidity and a host of other factors.

As an example, many junior mining companies raise money through IPOs before they have identified significant deposits to mine. Because they earn no revenue, they raise equity to fund exploration, with land being their only asset.

On the other hand, a manufacturing company would typically be at a more mature stage before proceeding with an IPO. They would have an established manufacturing and logistics operation in place, as well as a stable management team. These help assure investors that the company’s revenues will grow over the years, that safeguards are in place against disruptions and, should the unthinkable happen, that assets can be sold off to cover some of the investors’ losses. This reduces the risk of the equity and increases demand for the stock.

“Generally speaking, only companies of a certain stature are accepted on the principal exchanges in Canada,” says Nicolas Castonguay, Senior Account Manager, Technology Industry at BDC. “If a company is highly profitable, has great products or a brand people know, then there’s likely to be demand for its equity, while the opposite is also true.”

He says the typical IPO requires a seasoned company and a significant outlay of funds.

The Toronto Stock Exchange (TSX) is the country’s largest exchange, and part of the TMX Group, which also controls the TSX Venture exchange, TSX Trust, the Montreal Exchange and others. Smaller businesses seeking to go public may find themselves listing on the TSX Venture, while more mature companies are more likely to trade on the main TSX exchange. Either way, becoming a public company in Canada requires rigorous preparations and changes to internal structures.

How to prepare a business for an IPO

To prepare for an IPO, listing companies will require the following:

  • plan for corporate governance post-IPO
    This would include a description of its board of directors, including the board’s initial members as well as its mandate and committees. At this stage, your company’s external legal team would vet the plan to ensure regulatory compliance. Listing on the TSX, for example, also requires an audit committee of at least three independent board directors.
  • detailed business plan
    This includes specifics on how the funds from the IPO will be deployed.
  • review of the company’s capital structure
    This will ensure that it will continue to operate smoothly post-IPO and comply with applicable regulation.
  • company prospectus
    The prospectus needs to be filed with securities regulators in the jurisdiction where the company is seeking to be listed. Expert help is normally required.

How to list shares for sale on an exchange

The first step to listing your company will be to select experts who will help it prepare for its IPO.

An accounting firm will be needed to audit your company’s financial statements; experienced auditors will also identify which practices meet the standard for a public company and which ones don’t. This work will help the company’s finance team to complete their reporting after they have listed.

An investment bank is also needed to lead the sale and marketing of the company’s shares. The lead investment bank also carries out due diligence on the company. Most notably, it will help put together the company’s prospectus, which must be approved by the regulator before the listing can take place. In Canada, every province and territory has its own regulator. A list of these regulators can be found below.

To help sell the stock, banks typically create a syndicate, where one bank takes the lead with others taking on supporting roles.

The team of specialists also includes a law firm to ensure regulatory compliance and provide advice. It also plays a key role in the drafting of the prospectus.

Once this team is in place the listing company can set about the process of putting together its prospectus to be submitted to regulators.

Canadian securities regulators by province and territory

Jurisdiction Securities regulator (link)
Alberta Alberta Securities Commission
British Columbia British Columbia Securities Commission
Manitoba Manitoba Securities Commission
New Brunswick Financial and Consumer Services Commission
Newfoundland and Labrador Service NL
Northwest Territories Northwest Territories Superintendent of Securities
Nova Scotia Nova Scotia Securities Commission
Nunavut Office of the Superintendent of Securities
Ontario Ontario Securities Commission
Prince Edward Island Prince Edward Island Office of the Superintendent of Securities
Quebec L’Autorité des marchés financiers
Saskatchewan Financial and Consumer Affairs Authority
Yukon Yukon Superintendent of Securities

When applying for an IPO, your company will be required to file a prospectus with the regulator in the province or territory where the exchange on which you intend to list is located. This is mandatory, except in rare circumstances.

The prospectus provides regulators with detailed information about the company. Review and approval of the prospectus by regulators is key, and regulators can ask for structural or reporting changes before approving the listing.

What is a SPAC?

The past few years have seen a sharp increase in the use of special purpose acquisition companies (SPAC).

SPACs are listed companies that are formed for the purpose of raising money through an IPO to acquire or merge with a private company.

SPACs can be used to take a company public without having to go through the IPO process. They have existed for decades but have seen a spike in popularity over the past 10 years.

“They are created for the express purpose of acquiring a private company looking to go public,” says Castonguay, adding that companies choose to be acquired by a SPAC because it makes going public easier.

He says listing via SPAC is also less costly, with the work required from bankers, accountants and lawyers being a fraction of what a traditional IPO involves. However, it is not clear that a SPAC can deliver as much value as a traditional IPO to founders and shareholders.

What is a reverse takeover?

A reverse takeover (RTO) is another alternative to IPOs and SPACs. RTOs happen when a privately held company purchases a publicly traded company. The shareholders of the private company then exchange their shares for those of the public company. This effectively makes the private company a public company.

Castonguay notes that RTOs are only used in rare and specific circumstances. “Reverse takeovers are not for everyone. It’s true that they’re less costly and time consuming than traditional IPOs, but there can often be complicated record keeping issues to reconcile—one among a number of other potential issues,” he says.

SPACs and RTOs don’t qualify as traditional IPOs. An IPO is when a new asset is listed for sale on an exchange for the first time; for SPAC transactions and RTOs, the shares are already listed. In those types of transactions, the listed company is either acquiring or merging with a private company for the purpose of taking it public in the case of the former, or in the latter instance the private company buys the listed company. While additional shares may be issued in the case of an RTO, it is not a listing of a new security, as would be the case for an IPO.

Post-IPO outcomes

Whether a company is better off going public or remaining private depends on the company’s objectives and what resources are at its disposal.

Company founders will often take a company public so that they can raise the capital needed for a growth trajectory.

In some cases, founders and private investors may be looking to cash out after years of involvement in the company. In such a scenario, an IPO may be the right move.

There are some companies that will avoid the IPO route entirely, especially if the founders are not planning to step away from the business, and enjoy running the company as they see fit. They may also find that the public reporting, regulatory compliance and investor scrutiny that comes with having an IPO conflicts with their objectives.

Next step

Want to learn more about how companies are valued, purchased and sold? Download our free guide for entrepreneurs, Business Valuation.