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An IPO | Stocks and bonds | Finance & Capital Markets | Khan Academy - YouTube
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In the last offer--
in the last video,
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not the last offering.
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I guess it was a bit of both.
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We had completed our Series B.
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We had gone back to the till.
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Got another round of venture
capital funding.
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And we raised $10 million more
that's going to help us build
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out the website and do some
marketing, and hire up some
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more engineers and
other employees.
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And to do that we had to sell
one million shares.
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We essentially sold them
at $10 a share.
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And so after that offering,
well, our pre-money valuation
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was $30 million and our
post-money is now $40 million.
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That's the value of our assets
as-- I mean, the website,
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that's kind of an arbitrary
valuation.
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And I've gotten a letter
asking, well, how
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do you value that?
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And that's a whole subject
for another playlist.
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And I will do that.
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I will do a whole playlist
on valuation, eventually.
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But, to get there, the first
thing to understand is just
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the capital structure
and how capital
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markets work in general.
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So that's what we're
doing here.
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But anyway, so after you got the
$10 million-- you had $30
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million before, you get $10
million, your post-money is
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$40 million.
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And we had to issue a million
extra shares to do it.
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So before the money we had three
million and now we have
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four million shares.
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So let me draw what our balance
sheet looks like.
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So we had $1 million and then
we raised $10 million more.
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So if we look at the left-hand
side of our balance sheet, we
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have $11 million in cash, and
we have our website and
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intellectual property.
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Maybe we have some
patents now.
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So you can say assets
of the firm.
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I guess you could say non-cash
assets, right?
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That's cash.
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And some of them could be
intangibles, like branding.
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Or maybe we made some small
acquisitions of other people.
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And we'll do more videos on
actually the mechanics of
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acquisitions and all that.
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But you get the idea.
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These are all of the other
assets of the firm, whatever
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they may be.
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And then on the equity side,
because we have no liability,
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so in this case assets will
be equal to equity.
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On the equity side of the
equation we just have four
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million shares.
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1/4 went to the Series B guy,
1/4 went to the Series A guy.
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He had bought a million shares,
I think it was at
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$7.50 a share.
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Then the angel investor had
given us a million shares at,
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and I think it was $5 a share,
that was the angel.
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And then there's me and my
buddies, we split the last,
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that first million
shares five ways.
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And if I wanted to draw my
sliver, I still have my
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200,000 shares.
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And we could keep doing that.
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We could get a Series C
and a Series D that
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will keep us going.
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But let's say that a couple of
other people have decided to
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sell socks on the internet.
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And we realize this
is becoming a
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very competitive space.
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And we really want to just
lay down the gauntlet.
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And make sure that ours is
the dominant player.
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Because we figure that whoever
gets the biggest market share
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fastest, is going to become the
Amazon.com and everyone
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else is going to turn into
these me-too players and
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they're all going to
go out of business.
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So size has benefits
in this situation.
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So we don't want to do these
piddly $10 million offerings
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and $20 million offerings.
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We want to go big time.
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We say, you know what?
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We're going to expand our
company huge, we're going to
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push marketing hard.
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And so we want to raise
a lot of money.
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Let's say-- let me make up a
number-- let's say we want to
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raise, I don't know, we want
to raise $50 million.
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$50 million to invest in
the business and do
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some hard-core marketing.
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And it happens to be at a time--
let's say it's 1999.
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The stock market is
racing ahead.
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People would love to get in
on this kind of stuff.
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So we say hey, let's do an
initial public offering.
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And then that has
two benefits.
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One, we will be able to raise a
lot of money for the firm to
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invest in maybe building
distribution centers or the
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marketing that I talked about.
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And the other side benefit,
which we won't really talk
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about much at the board meeting,
but all of these
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people right now, they're all
holding these shares, right?
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I have these 200,000 shares.
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This angel investor has
this million shares.
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And there's really not a lot
they can do with them, right?
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Maybe the angel investor, maybe
he had an expensive
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divorce settlement and he has to
make some alimony payments
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now, and he doesn't really
have the cash.
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He can't do anything with
these shares, right?
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Same thing with these VCs.
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These VCs are accountable
to their investors.
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And they can say-- like, this VC
can say oh, you know what?
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I bought those shares at $7.50
per share, and then this guy
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came and bought it at $10 per
share, so I already got a 33%
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gain on my investment.
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But the investors aren't that
impressed by that, because
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you're still holding
the shares.
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You can't really say they're
worth $10 until you actually
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turned them into $10.
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Or you turn them into
actual cash.
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So, by doing an initial public
offering, all of a sudden all
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of the players will
have liquidity.
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Which means they can
exchange what they
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have, including myself.
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So they can exchange what they
have for actual cash
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if they need to.
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So how does that work?
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So I would go to an investment
bank, although they've all
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turned into commercial
banks now.
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But we're talking in
a pre-2008 world.
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I would go to an investment
bank and I'd say-- or more
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likely they would come to me
and say hey, you guys could
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raise big money in the public
markets right now.
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Why don't you do an IPO?
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And in a few seconds you'll
realize why they are
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so keen to do it.
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And I say, sure.
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We can raise a lot of money.
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And also we'll be in the press,
so that'll be free
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marketing in and of itself.
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So I say sure, do
all of the work.
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So what they'll do, is there
will be a lead underwriter.
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Let me write that down,
lead underwriter.
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And that's essentially the
person who does all of the
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legal work.
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They're going to file documents
with the SEC that
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describe the company.
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And they're going to
make models and
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projections and all that.
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And then they're also going to
have people riding along with
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them, other banks.
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And they're going to
form a syndicate.
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A syndicate is just a group of
banks that work together to
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kind of handle a larger
transaction than any one of
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them would be willing to
handle by themselves.
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And it kind of spreads the
risk amongst them.
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So the bottom line is what the
banks do, other than doing all
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the legal work.
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They'll value the company and
then they'll go to all of
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their clients.
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So all of the people who trade
through that bank, all of the
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institutional clients, all of
the hedge funds that have
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their prime brokerage accounts
at those banks.
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And just so you know, a prime
brokerage account is just like
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a brokerage account, but
it's a brokerage
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account for big guys.
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It's a brokerage account for
people managing $100 million
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and not their E-Trade account.
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That's all a prime
brokerage is.
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And they'll go to these guys and
say hey, we have this hot
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IPO issue, socks.com.
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And we've done our models,
and we think this is
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a $5 billion market.
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We think that this company is
worth-- we think this company
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is worth at least $100 million
in its current form.
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So once again realize, I mean,
even though we're kind of
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doing something a little
different now, all of the
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other things were essentially--
you could call
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them private offerings.
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Or private placements
in some way.
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Essentially these were
private equity sales.
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And I know that word is used
a lot, private equity.
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And that's what venture capital
essentially is.
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Although normally when people
talk about private equity,
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they're not talking about
venture capital.
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And I'll do a whole other
video on that.
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But venture capital
fundamentally is private
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equity, right?
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Because these shares that you're
selling, they're not
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traded on a public exchange
like the New York Stock
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Exchange or the NASDAQ, or
something like that.
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So anyway, back to what
we were doing.
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These guys, these banks, they
go to their clients and say
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hey, I have this
hot new issue.
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And they'll kind of
gauge sentiment.
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They'll talk to clients, they'll
talk to each other,
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and they say, oh you know
what the demand is.
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And they'll essentially come up
with some price, which is
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essentially as a high a price
as-- they want do a high price
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because obviously as a company,
I want to sell the
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stock for as much as possible.
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But they don't want to do it
so high that the stock
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doesn't trade up.
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Most banks, you want your
IPO to look like this.
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This is the first
day of trading,
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this is your IPO price.
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They want it to look like that,
so that in the future
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when there's an IPO, people
get excited to get in it.
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If this IPO-- if the stock just
did this, if it started
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collapsing, one, people
will lose
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interest in IPOs in general.
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And then people will get
suspicious about this company.
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And I'll do a whole
video on that.
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So, how do the mechanics work?
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Well, they'll say, hey, you want
to raise the $50 million,
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well you could do it
a couple ways.
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We say hey, we're willing to
issue another-- let me think
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of the best way to explain--
we're willing to issue another
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ten million shares, right?
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And I'm not drawing
it proportionally.
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Let's say we're willing to
issue another ten million
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shares, and this should be a
lot higher, because this is
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four million right here.
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We're willing to issue a another
ten million shares,
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how much money can
we get for it?
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And let's see, these bankers
talking to essentially the
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market, and talking
to each other.
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They say hey, we think we can
justify these guys, and we're
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going to do it for a little
bit lower than they're
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actually worth.
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But we think the market will buy
the fact that these guys
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are worth, I don't know, let's
say they're worth $80 million
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in their current incarnation,
right?
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Which essentially says, before
we raise the money, we have
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$80 million, we have four
million shares.
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So they're saying $20 a share.
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So if we go and issue another
ten million shares at $20 a
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share, we'll actually
raise $200 million.
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Actually, for the sake of-- so I
don't have to edit my math--
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let's say that's how much we
wanted to raise, $200 million.
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So essentially what these guys
will do, our board of
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directors will issue
these new shares.
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And then this syndicate of
banks, led by the lead
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underwriter will then sell it
to their brokerage clients.
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To mainly institutional
investors, but it might be
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some favored rich guys.
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If it's not that favored of an
IPO, maybe you might get a
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call as well.
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And they'll sell it
to all of them.
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And you say, why are
they doing that?
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Why are they doing all of this
work for the company, helping
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them raise $200 million?
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And they're going to the pain
of the legal work, and they
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had to put a team of maybe
ten guys on this.
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And they had to make models,
and it probably took them
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maybe two or three
months to do it.
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That's a lot of work,
what do they get in
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exchange for all of this?
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Well they actually
get a commission.
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And that commission, at least
historically, has been 7% of
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the offering.
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7% of the offering.
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And now you get a sense of why,
in a good market, when
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you can do these things, why it
has, in history, paid to be
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an investment banker.
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Because 7% of $200 million--
and frankly it's not a lot
[660]
more work to do a $200 million
offering than it is to do a
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$20 million offering,
it's probably
[665]
about the same amount.
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But 7% of $200 million
is $14 million.
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So actually these guys aren't
going to see $200 million.
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They're going to see 200
minus 14 million.
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So they're going to
see $186 million.
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And then these bankers are going
to split $14 million.
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And that probably is about
two months of work
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for maybe ten guys.
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So you can imagine-- and of
course they have the whole
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bank that has the support, and
they have all these-- not
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anyone could do this.
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You have to have what they
call retail distribution.
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You have to have kind of a
channel that you can plug
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these shares into to
actually get rid of
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the ten million shares.
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You see, it's a fairly
profitable business.
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So that's what an initial
public offering is.
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For the first time, a company
is selling shares to the
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public, that is not just to
these private investors.
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And usually on an initial public
offering, although it's
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not always the case, these
guys aren't selling their
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shares as much as they
would like to.
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They're usually locked in for a
certain period, just because
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it looks bad if, especially the
insiders-- those were the
[730]
founders of the company--
actually sell their shares.
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But six months later, then I
can go and sell my shares.
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Maybe if I do it on a small
amount, I can go and sell it
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in the NASDAQ.
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And I have a publicly traded
price, so on any given day, I
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know exactly what my
shares are worth.
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And this is an important
thing to realize.
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Because a lot of times when
people buy a stock they're
[749]
like, oh, I've invested
in that company.
[752]
Well, kind of.
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When you normally buy a stock
on an exchange, as the New
[756]
York Stock Exchange, you're
just buying the stock from
[758]
somebody else.
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You're not buying the stock
from that company.
[760]
So when you pay $100 for an IBM
stock-- I've run out of
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space, that's why I'm just
talking and not drawing, let
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me erase this.
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I've run out of time, too.
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But I think this is an
important point.
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When you buy stock from someone
else-- so if I give my
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$100 and I get a stock
certificate of IBM, most of
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the time, if I were to do this
today, I'm just-- this is me,
[787]
with a mustache-- I'm just
getting it from some other
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dude, right?
[793]
Well maybe he's happy
because he got $100.
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He's got a top-hat.
[799]
And this is what happens in the
stock market every day.
[801]
So when I buy that, I'm not
really investing in IBM.
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I'm just buying the money--
I'm just buying that share
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from another guy.
[807]
We're just exchanging shares.
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In an IPO, if I'm one of the IPO
investors-- this is me--
[816]
my $100 in this situation--
let's see we're
[820]
dealing with socks.com.
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Maybe that's it's ticker
symbol, SOCK.
[827]
This time it's actually
going to the company.
[830]
It's actually going to the-- or
the website, in this case.
[832]
Of course 7% is being
re-directed to
[836]
the investment bankers.
[838]
So when you buying from and IPO
you really are, to some
[840]
degree, making an investment.
[841]
Just like if you were doing
a venture capital.
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You really are making an
investment in a company.
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Your money will then be used by
the company to hire people
[848]
and build factories
and make out a
[850]
website and do marketing.
[851]
In this case, you're essentially
just trading
[853]
shares in a secondary market.
[856]
Secondary market just means
that it's not going to the
[859]
actual company.
[860]
It's just going to another
shareholder who bought it
[863]
before you.
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Anyway, I've really gone
over my time limit.
[867]
So I'll see you in
the next video.
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