What is an IPO? A beginner’s guide on how crypto firms can go public

What is an IPO? A beginner’s guide on how crypto firms can go public

An initial public offering (IPO) is a process in which a private company sells crypto assets of its business to the public in new issuance. The process allows a cryptocurrency company to raise capital from public investors, but it will have to comply with regulations that force it to increase its disclosures and transparency.

Before an IPO, a company is considered private and is owned by a relatively small number of stakeholders. These stakeholders can include early investors like founders, the founders’ family and friends, or venture capitalists who provide capital to companies with high growth potential.

An IPO is a big step for any company and is seen as a milestone for businesses in the cryptocurrency space from a regulatory standpoint. In their early days, cryptocurrencies were seen as scams or get-rich-quick schemes, so companies dealing with cryptocurrencies were seen as fraudulent projects.

To launch an IPO, a crypto company needs to engage with underwriters or investment banks, which are parties that evaluate and assume risks in exchange for a fee, to launch their coins to the public. Underwriting is the procedure through which an investment bank (the underwriter) serves as a broker between the issuing firm and the general public to assist the issuing company in selling its initial set of coins.

After an IPO, the company’s crypto assets trade on a crypto exchange, which is a market where securities are bought and sold. As a result, an IPO is often known as “going public.” Being publicly traded also increases reporting standards because of regulatory requirements, and improves the perceived prestige of the crypto company, as it manages to meet all of its obligations.

Businesses start off being privately owned. When they grow to a point where they can deal with publicly traded benefits and responsibilities, they start advertising their interest in being listed on a crypto exchange.

Before being listed on an exchange or publicly traded, the value of share ownership in a company is determined in private deals only. After being listed, the value of the business’ coins is determined by the supply and demand of securities traded on the exchange.

The Dutch East India Company is credited with being the first to offer crypto assets of its business to the public, regarded as the first IPO in the world. Since then, various major companies have sold coins to the public via IPOs, including some leading cryptocurrency firms.

How an IPO works

When a company has matured to the point where it can handle the responsibilities of being publicly traded and is looking to benefit from the prestige, added volume and exposure from an IPO, it starts to show interest in the process of going public.

The process, which is similar to companies both in and out of the cryptocurrency space, has a few steps that need to be taken:

Steps to launch an IPO

However, initial coin offerings (ICOs) are used to sell crypto equity to the general public. Blockchain firms seeking funding can sell cryptocurrencies to the public as traditional stocks do through initial public offerings (IPOs). The issuance of digital tokens that backs an organization's equity shares is referred to as crypto equity. It's becoming a popular technique for businesses to raise funds by issuing cryptocurrencies. When users buy crypto stock from an ICO, the company's shares are placed in digital tokens into their blockchain-hosted account.

Companies have two ways of showing interest: They may solicit private bids from underwriters or investment banks, or make public statements regarding their interest in an IPO to generate interest from the concerned parties and the public.

The company going public may choose one underwriter or a syndicate of underwriters to manage different stages of the IPO process. The investment bank or an underwriter is chosen based on its reputation, research quality, industry experience, distribution (i.e., whether the investment bank can provide issued securities to more institutional or individual investors) and the firm's previous association with the investment bank. These underwriters help manage every aspect of the process, including preparing for the filing, documentation to be shared with regulators and the public, due diligence, marketing, how coins will be issued and at what price.

 A team of underwriters, lawyers, certified accountants and regulatory experts is often assembled to be registered under the IPO (with market regulators in the country where the coins will be made available). In the United States, a filling has to be made with the Securities and Exchange Commission (SEC).

In the U.S., the primary IPO filing document is the S-1 Registration Statement. The document includes preliminary information on the company’s financials, the risks surrounding its operations and information on its management

The market regulator has to approve the IPO application, but it does not end there: The crypto exchange in which the coins will be traded also needs to approve an application. The crypto company that is to be publicly traded has to adhere to listing requirements from both regulators and exchanges. After the issue's parameters have been agreed upon, the SEC requires the issuing business and its underwriters to file a registration statement. 

There are two sections to the registration statement:

Key sections of the registration statement

The registration statement ensures that investors have access to sufficient and trustworthy information about the securities. After that, the SEC conducts due diligence to confirm that all required information has been disclosed appropriately.

After all necessary approvals, the IPO is promoted in a roadshow (called the dog and pony shows – lasting for 3 to 4 weeks) that aims to generate interest and allow the underwriters to estimate demand for the coins being issued. Throughout the marketing process, underwriters may make revisions to their analysis of the firm, which may lead to changes in the IPO price or date. A board of directors is also formed to represent the crypto holdings and the company’s administration.

The company’s tokens are then issued on the IPO launch date with an allocation reserved for the underwriters who helped it trade on a public crypto exchange. The capital invested in buying the issued tokens is received as cash in the coins paid in.

Not everyone is able to invest in IPOs, as demand often exceeds the number of coins being sold to the public. Often, brokerage firms only let clients with specific amounts of assets or those who meet certain trading thresholds participate in IPOs. 

Existing token holders may be subject to lock-up agreements that prevent them from selling their coins right away. If investing in an IPO, it is important to consider these lock-up agreements. When they end, existing token holders may sell all of their coins on the market, leading to price drops.

Often, underwriters price IPOs at a discount to ensure that there’s more demand than supply. The price is set after the company is valued using several indicators including how much money they are expected to generate in the future.

After an IPO, the price of a company’s coins may fluctuate wildly as investors who did not manage to buy during the IPO itself get in, and as existing coin holders adjust their positions. If underwriters and investment banks overly promote an IPO, the coins may suffer substantial initial losses once trading starts.

An IPO’s coins may also be priced using a Dutch auction, which sees potential investors enter their bids for a specific number of coins they want to buy along with the price they are willing to pay. The coins are then sold according to the lowest bid for the entire allotment.

Reverse IPOs

A reverse IPO is another method private cryptocurrency companies can use to start being publicly traded. In a reverse IPO, a private company takes control and merges with a dormant public company.

Often, these dormant public companies are businesses set up with the specific purpose of going through an IPO so they can later be used to help private companies go public. A reverse IPO is a process that takes between a few weeks to a few months, while a conventional IPO process can take up to a year.

A reverse IPO is used to become publicly traded without any investment banks or underwriters being hired and any capital being raised and occurs when a private company acquires a publicly traded company. Companies that go public through reverse IPOs, which are also known as reverse mergers, still benefit from the advantages of being publicly traded, including the added liquidity. Liquidity refers to the ease with which an asset can be bought or sold.

During market downturns, investors may not be willing to risk their funds on a newly listed company, leading to unsuccessful IPOs. Reverse IPOs are less affected by market conditions than conventional IPOs, which rely on investor demand to sell their coins.

IPO alternatives

Not all companies have to be publicly traded, some of the largest businesses in the world are privately-owned and seemingly have no plans of going public. Similarly, not all companies have to go public through an IPO, as other alternatives are out there.

IPO alternatives

One such alternative is a direct public offering (DPO), also known as a direct listing, in which companies offer securities directly to the public to raise capital without using underwriters. In a DPO process, investment banks are hired as financial advisors who help with regulatory and exchange approvals and find an initial share price.

DPOs may be especially attractive to cryptocurrency businesses that are well-known in the digital assets space. Such an offering substantially lowers the cost of going public by cutting out the middlemen; direct listings do not dilute the value of existing coin holders’ equity, which also means the company does not raise funds.

Another alternative to IPOs are special purpose acquisition companies (SPACs), which have no commercial operations to acquire a privately-owned company, effectively making the private company a publicly traded company. SPACs raise money through conventional IPOs and place the funds in interest-bearing investments until they are used in an acquisition.

Experts can form SPACs within specific industries to acquire a popular company in their space. Cryptocurrency experts could band together and IPO a SPAC in a bid to buy a private company in the space. At the time of their IPOs, SPACs often do not reveal their acquisition target to avoid disclosing too much information in their S-1 filing.

IPO advantages

Initial public offerings have a number of advantages for companies with the main one being raising capital. For cryptocurrency companies, a significant advantage is the increased exposure and the added prestige that comes with being publicly traded.

Publicly traded companies have to increase their transparency, as they have to update investors and shareholders every quarter on their financial and strategic situation. Increased transparency and the prestige of following every regulatory requirement to IPO and maintaining a public listing give crypto companies a better public image, benefiting the sector as a whole.

A company’s increased exposure while being publicly traded may also bring in new customers. A crypto company that has worked with regulators and crypto exchanges to IPO is bound to be more trustworthy than a business in an early stage. Moreover, the quarterly reporting clarifies a crypto company’s financial situation, leading to more favorable credit borrowing terms.

As anyone in the public can buy and sell the company’s coins, the liquidity of these coins receives a huge boost. An increase in liquidity adds value for existing coin holders, as it makes it easier for them to sell part or all of their holdings.

Through an IPO, a company gains access to public markets and can more easily raise additional funds through secondary offerings. These secondary offerings are essentially the sale of new or privately held coins of a company that has already made an IPO.

A secondary offering may dilute the value of other coins on the market by creating new coins and offering them for public sale. Alternatively, one or more major coin holders may sell their holdings in a secondary offering, in which case they would receive the proceeds from the sale.

Finally, if a company is publicly traded, it can offer compensation in its coins, which are more liquid because of the crypto exchange listing. Better management can be attracted through coin incentives while being incentivized to help the company grow. If the company’s value increases, the price of its coins or tokens will follow the same trend. 

IPO disadvantages

Choosing to make an IPO and having coins available on crypto exchanges brings companies added effort, risks and expenses. These added risks and expenses may be so significant that many in the cryptocurrency and other sectors would rather remain private.

The process of making an IPO is itself expensive. The company has to hire underwriters or investment banks that need to be paid. On top of that, the costs of producing reports on a company’s situation every quarter become ongoing, and unrelated to their business operations.

Legal and accounting costs also grow, as the company has to remain compliant. Without increasing these costs, there’s added risk of legal or regulatory complications that could lead to class-action lawsuits. In the cryptocurrency space, there are several class-action lawsuits against both private and public companies alike.

As publicly traded firms have to disclose financial, strategic and other information, they may end up having to disclose something that their rivals can use to gain market share over them. These disclosures may help the company gain prestige and have better credit borrowing terms but may also affect their businesses by aiding competitors.

On crypto exchanges, a company’s coin price fluctuates throughout the year, and these fluctuations may end up being a distraction for management, especially if executives are compensated through equity. In some cases, it may end up leading to strategies meant to inflate the company’s crypto price, rather than growing its business.

These strategies meant to inflate a company’s price can have long-term consequences. Suppose a company, for example, uses its reserves to buy back crypto from the public. In that case, it may end up in a situation where its reserves would be needed to get the upper hand over its competitors, develop a new product, or launch in a new market. Crypto buybacks, it’s worth noting, occur when a company buys back coins from the marketplace with its cash reserves.

Another major disadvantage of an IPO is it opens the door to activist investors. Activist investors buy significant stakes in public companies to influence how they are run and can use their influence to make the company go in a specific direction. That direction may even mean going private again.

The influence of activist investors has its pros and cons, but both sides of the coin may lead to instability at a public company as these are stakeholders with large amounts of coins that are looking to get new results. These results may not always be positive over the long-term horizons.