IPO and Order Types

When a company needs to raise capital, it issues securities — stocks, bonds, whatever (this is called floating the security).

Now, the place where these freshly-issued securities get sold? That’s the primary market.

And the kind of “used market,” where securities that were issued some time ago get traded between people — that’s the secondary market.

There’s also a distinction between a company issuing securities for the very first time and a company that already issued some in the past now issuing more.

For common stock, the first issuance is called an initial public offering — IPO. It’s what a private company does when it makes its first “public reveal” to the world.

When a company that’s already done an IPO issues more common stock later on, that’s called a seasoned new issue.

Bonds are the same idea. The first issuance done when going public is a public offering, and issuing again afterward is a private placement.

OK let’s go a little deeper.

To explain public offerings in more detail — you want to issue securities for the first time, right? The company doesn’t just hand them out to the public itself. An IB has to underwrite them first.

That is, an Investment Bank handles the whole pipeline of getting newly-issued securities into the public’s hands.

First, the company has to get approval from the SEC. Once that approval lands, a preliminary prospectus gets distributed to investors.

After that, the executives have to scramble off to do a road show — meaning, they go around to investor after investor doing presentations explaining the business. That’s a road show.

The road show has two main goals.

First, you’ve gotta explain real well what kind of business you’re running. Only then will investors actually put money into your securities.

And the second goal, which honestly seems like the more important one —

Forecast the demand in the market!

So as you make the rounds and ask around a bit, you get a rough sense of how much demand there is and what kind of price the market is anticipating. This is called bookbuilding (i.e., demand forecasting).

But hold on — can you really trust what people say?

What if they tell you one thing, and then when you actually try to sell, they’re like “nah, not buying”…

Wait, and another thing — if people say they’re not very interested, the securities will get priced lower, right? And the lower the price, the cheaper investors can buy in. So wouldn’t it actually be in the investor’s interest to play it cool and say “eh, not interested”?

Apparently, nope. Because the IPO allocation itself is doled out in proportion to how strong your expressed interest was. And on top of that, IPOs in general tend to come out priced relatively cheap. So the smart play is actually to express your real interest, get a bigger allocation, and pocket the bigger profit.

(That said — not every IPO stock comes out cheaper than market. Some of them do drop after the IPO.)

But this is all only relevant for institutional investors anyway… As an individual investor, the amounts involved are not amounts a normal human can swing.

One more thing worth introducing — there’s a kind of moral-hazard situation that can pop up around IPOs. It’s called spinning.

Some IBs use IPO stock allocations as bait to extract favors from company insiders… That’s spinning.

And why does this kind of thing even happen? Because the authority is all concentrated in the IB, right? The underwriter generously hands a chunk of IPO shares to some company’s CEO, and in exchange they get… something. Not necessarily money — more like, future business gets locked in, all kinds of little favors trade hands, that sort of thing.

OK now let’s look at private placement.

That “private placement” you hear about all the time in the news — like private equity funds and stuff — that “private”!

In English it’s private placement: meaning, “I’m gonna distribute these securities privately.”

So instead of selling them out to the general market like an IPO, you hire a single IB, and the IB just sells them directly to a handful of institutional investors or wealthy individuals.

Private placement costs way less than a public offering!!! Because you don’t have to file all those expensive registration documents the SEC demands.

The downside, though, is that there’s no secondary market for it… so liquidity is low. (Which is exactly why it’s cheap.)

OK so I jumped ahead a bit and introduced IPO and private placement first — let’s circle back. I should probably actually talk about IB now…

Stocks or bonds that get publicly offered generally use an underwriter. The underwriter underwrites them, then turns around and sells them to the market. The shop that does this kind of work is the IB, the Investment Bank.

What are some IBs whose names you’d recognize? Hmm…

Lehman Brothers — the one that triggered the global crisis???? You’ve heard of that one at least once, right? Also an IB.

JP Morgan, Merrill Lynch, Goldman Sachs — also IBs.

Except for JP Morgan, they’re all gone now. Collapsed.

(Korea doesn’t really have IBs… There’s no IB per se, but the role gets played by securities firms.)

Anyway, when you want to issue securities, you bring in these investment banks (usually 2 or more) to participate in the sale.

The biggest dog among them is called the lead firm, and the whole underwriting crew formed around the lead firm is called the underwriting syndicate.

What’s the most important skill these guys gotta have????

A silver tongue? Crazy analysis chops?

Nope. They gotta eat well.

lol they better drink well too lol — and what else??? It helps to know a lot of fancy entertainment spots, etc. etc.

Which is worse for this kind of stuff — Korea or the US?

The US is apparently like 10,384,798 times worse.

Anyway. The investment banks have to submit to the SEC (Securities and Exchange Commission) a preliminary registration statement / preliminary prospectus that lays out the securities being issued, the company’s outlook, all that good stuff.

This document is also called a red herring, because there’s a phrase printed in red lettering on it stating that the securities can’t be sold before approval.

The moment SEC approval lands, this becomes the actual prospectus.

And the moment that happens — somehow they all seem to know among themselves when it’s going to happen — the public offering price of the securities gets announced.

There are a bunch of different methods of underwriting securities, which we’ll get into in more detail later. For now, just remember the rough flow: road show → bookbuilding → SEC approval → price announced. Got it?

Types of orders

Market order.

Literally just, place the order at market price.

You call up a dealer, or a broker… (a dealer and a broker are different things~)

“I’m gonna buy such-and-such~” you tell them.

“Ah, that’s $90.5~”

And then, file that away in your head… a few days later another call comes in: “I’m gonna sell this~”

“You can dump that right now if you list it at $90!”

The middleman eats the $0.5, and the trade settles at $90. heh heh heh

(However! If the quantity is huge, this whole mechanism falls apart. Because the posted quote is only good up to a certain volume.)

Beyond just slamming it through at market price like that, there’s also a limit buy order.

Instead of selling immediately at the current market price, you set a limit, and when the market price hits your limit, then the trade goes through…!!!

For example: a limit sell is where the stock has to climb above a price you set in advance — only then!! does the trade execute. And once the market price reaches your limit, from that point on it just runs like a market order… heh heh

Then there’s the stop order.

This one’s similar to a limit order in the sense that the trade doesn’t fire until the stock hits some threshold, but the weird thing is — you sell when the price falls below the limit, or you buy when the price rises above it.

That’s the order type.

It seems a little~ backwards from how the market normally works, right?

And the reason it seems weird is, it’s used when you’re doing something weird. And when you’re doing something weird, the tool you’re using is also weird. lol lol lol

As we’ll talk about later, this kind of order isn’t designed to maximize your gains — it’s designed to minimize your losses.

This is the kind of thing that gets used when you’re doing short selling.

Originally written in Korean on my Naver blog (2016-04). Translated to English for gdpark.blog.