Initial Public Offerings (IPOs) have been a useful tool used by companies to finance their operations, for a long time. IPOs have enabled companies access funds without borrowing from lending institutions, as these attract high interest rates. In Initial Public Offerings (IPOs), a company sells its stocks to the public. Funds raised through this means may finance expansion projects for companies, in accordance with their strategic expansion plans.
There are four categories of IPOs; The first one is the Primary Offering and in this case, the proceeds of the offering go to company that is issuing it (Draho, 2004).The second is the Secondary Offering and in this situation, a major shareholder disposes his or her share of the company, with the proceeds going to them. The third is the Split Offering, which combines secondary and primary offerings. The fourth offering is called the Shelf Offering and it gives authority to a company to issue securities over a period of two years, depending on the financial needs of the company. Initial Public Offerings are handled by stock market experts, and is usually a contract between the issuer of the stocks and the underwriter.
The function of the underwriter is to find market for the stocks. This role is usually played by a collection of investment banks, led by the lead underwriter, with the help of other banks, collectively called the syndicate. There are two ways in which an IPO may be performed; the traditional way and the on-line auction. Traditional IPOs In this type of IPO, the company decides the capital figure that it wants to raise and subsequently calculates the number of shares that it will offer and at what price. This price is usually lower than the market price (Wallace & Winters, 2006).These shares are usually divided between institutional and retail investors and before the IPO, the company and underwriter carry out a road show to increase awareness about the offering, to institutional and large investors.
After the roadshow, the company allocates shares and in case of over subscription, investors get fewer shares than they applied for. After trading commences, the share price usually appreciates since it was initially discounted. An advantage of this type of offering is the favorable publicity gained when share price rises, when trading commences.A disadvantage is that it is expensive to carry out a traditional IPO.
Another disadvantage is that it favors large institutional investors. On-line auction This type of IPO uses the Internet to sell shares of a company to larger numbers of investors. Just like the traditional IPOs, the company and underwriter determine the shares to be offered, and the share price (James & Cunningham, 2007). A roadshow is also conducted, but in this case, shares are not allocated.
When bidding opens, the company sets a price that it does not expect bidders to bid and gradually increases it until someone bids.Those shares are sold and bidding continues until all the shares are sold. This type of bidding is called the Dutch auction. An advantage of this type of IPO is that it is relatively cheaper than the traditional IPO (Dornfes, 2004). Another advantage is that the share price is likely to be closer to the market price leading to a lesser price increases in the first day of trading.
This means that instead of profits being taken by investors, they remain with the company. The third advantage is that it gives a larger number of people an opportunity to buy shares, unlike the traditional IPOs.The weakness in this type of IPO is the loss of favorable reputation that is associated with high price increase, when trading commences. Another disadvantage is that the company may raise less capital than intended, especially if it overestimated its value. Google and Morningstar IPOs Morningstar employed on-line auction (Dutch auction) in its IPO.
This type of IPO was used in order to allow small investors take part in the offering. This is in line with Morningstar's policy that every person should be on an equal level (Friedman, 2004).The auction however saw the withdrawal of investment banks, William Blair, Deutsche Bank Securities and Morgan Stanley because they saw a potential threat to investment banks due to the lower charges of on-line auction. They did not want to be seen to endorse the process. Initially, Morningstar wanted to use the traditional IPO but changed its mind after the successful on-line IPO carried out by Google. Google IPO was also in the form of on-line auction (Dutch auction), and it raised over $1.
5 billion (Evans, 2001).Google ended up getting a share price that was below the expected range. The number of shares sold was also was also reduced by half. Insiders were unable to comment on the issue to the 'quiet period' though it was speculated that underwriters were unable to convince investors to buy shares at triple digits. This was compounded by the fact that investors complained about large volumes of insider trading and allegations of 'quiet period' violations preceding the offering. Second Life is a virtual 3D world that was created by Linden research company in 2003 (Cook, 1998).
It serves information, commerce and social networking needs of the over 1 million 'residents' who use the program. Harvard Law School took the program a step further when a class was taught in the virtual world of Second Life. This program simulates the real world and people live normal lives, spend money, buy land, meet friends, all in the virtual world of Second Life (Hirschey, 2002). People spend thousands of dollars each day in virtual casinos, islands, libraries, universities and others.
It Second Life undertakes an IPO, the offering is likely to attract many retail investors from all professions (Ghosh, 2006). Although a recent survey conducted indicated that half of the people who use Second Life are opposed to the idea of an IPO, if conducted, it is likely to rival the Morningstar IPO and raise revenues close to Google's. If the IPO is conducted, the best type of IPO to use is on-line auction. In this case, the Dutch auction is the best to use since it will ensure that small investors have the same likelihood of purchasing shares as the institutional investors.
Retail investors are arguably the most common clients that Second Life currently has and on-line auction would give them an opportunity to own a part of it. This will ensure that Second Life's interests are taken care of, with its clients running it. On-line IPO will ensure that most of the profits from the sale, go to the company, since the share price is not likely to increase as much as it would, if a traditional IPO is used. With the rapid growth of Second Life, this type of IPO will enable a larger number of people participate in it, than traditional the IPO.
However, since half its clients are currently opposed to the offering, the management of Second Life should wait until a favorable time before giving the offering (Hiraoka, 2005). This is because if the offering is done with the prevailing circumstances, it may result in Second Life raising lower than the expected capital. This is a case that was observed in Google's IPO, with lower share price attributed to negative publicity preceding the IPO. Conclusion Second Life has attracted diverse clients, with its wide range of social networking features.Most of the clientele is likely to be retail investors, in case of an IPO. It is therefore prudent to use on-line IPO to enable a wider range of people access it, at a uniform platform.
The management should however wait until the market is ready to avoid raising less than expected level of capital. In the meantime, the management of Second Life should be publicizing the benefits of a Second Life IPO to 'residents' in preparation of the offering. Second Life can even create a virtual IPO and simulate how the actual IPO will perform.
