Dutch Auction Initial Public Offering

In an earlier post, the traditional method of an initial public offering was summarized.  The price of the new stock is determined by the lead investment bank and the company.  Another method to set the offering price is to hold what is called a Dutch Auction.  This was pioneered by the boutique technology investment bank W.R. Hambrecht.  The bank sets the number of shares and share price for the IPO.  When the sales force engages their buy-side clients, they are given the number of shares wanted (indication of interest) and the price at which the client will buy the deal.  Once the minimum price is established, shares are issued to the clients that bid the minimum and greater.  The shares are at that price.

For example, the IPO may be set for 1,000 shares and $100 initially.  The aggregated bids from all investors may be:

• 200 shares at $100
• 400 shares at $95
• 300 shares at $90
• 400 shares at $85
• 500 shares at $80
• 500 shares at $75

The bids reach the 1,000 share level at $85.  The investors that bid $90 - $100 will receive 900 shares at $85.  The remaining 100 shares at $85 will be distributed to those investors proportionally.  If an investor asked for 100 shares, 100 x 0.25 = 25 shares would be allocated.  Any order under $85 would not be fulfilled.

This method is not popular with the banks because they receive a lower fee - about 2% of capital raised versus 7% - for the deal.  It is not popular with the buyside because it will usually not jump in price and pave the way for quick profit taking on the first day of trading.  On the other hand, the issuing company can get more capital from the IPO.