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11–8 Sell Shares in an Internet-Based Auction
11–8 SELL SHARES IN AN INTERNET- 213
BASED AUCTION 1
Any initial public offering (IPO) is an exceedingly expensive process, due to the
massive accounting, legal, and underwriting fees involved. In addition to these
expenses, it is entirely possible that the initial stock issuance will be somewhat
underpriced, because the underwriters have usually committed to purchase the
entire stock issuance from the company, and so want to flip their investment over to
investors as soon as possible. There is also some suspicion that they are pricing an
issuance low in order to sell shares to parties to whom they owe favors. Whatever
the case may be, the traditional IPO share sale tends to result in low prices, which
takes cash away from the company and forces it to issue more shares in order to
reach its cash target, thereby ceding more share voting control to outside entities.
An alternative to the traditional sale of stock through an underwriter is to use
an “OpenIPO” auction. Under this approach, potential investors download a
prospectus over the Internet from an underwriter that specializes in this type of
offering. If they wish to bid on the shares, they open an account with the under-
writer, select a bid price and the number of shares desired, and send the under-
writer a check for that amount. This bid can be withdrawn at any time prior to the
offering date. Based on the range of bids received, the underwriter then creates a
public offering price at which share purchases will be accepted (which matches
the price of the lowest bid received, below which all other bids exceed the num-
ber of shares to be offered). All investors bidding above this price will be issued
their full share allocations, while those whose bids were below the price will be
refunded their money. Those investors bidding the exact amount of the public
offering price will receive some portion of their requested number of shares,
depending on how many other investors requested shares at that price, and how
many shares are still available for sale. This approach tends to result in higher
share prices, resulting in either more proceeds flowing to the company or fewer
shares being sold (resulting in more control by the original shareholders).
For example, a company wishes to sell 1 million shares to the public.
Investors bid for 500,000 shares at $14 each, while bids are also received for
300,000 shares at $13.50 and 600,000 at $12.00. Since the entire offering can be
sold at a price of $12, this becomes the public offering price. All investors bid-
ding at prices of $14 and $13.50 per share will receive their full allocations of
shares, and will pay $12 per share. Of the 600,000 shares bid at $12, investors
will receive only one-third of their requested amounts, since this will result in 1
million shares being sold, which was the original target.
Cost: Installation time:

1 Reprinted with permission from Chapter 16 of Steven M. Bragg, The New CFO Leader-
ship Manual (John Wiley & Sons, Inc., 2003).