Online Investment Bank

By: EconomyWatch   Date: 9 September 2010

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Online investment banks nowadays provide companies with the option to allocate their shares through an online auction process. Researches have proved that turnover in the after market trading is significantly higher in the case of online IPOs (Initial Public Offerings) as compared to traditional ones. Electronic markets also has the advantages of increased personalization and customization of IPOs according to one's needs.

Online Investment Bank- An Electronic Boom & Boon:

           Information Technology has dramatically changed the structure of markets in the last few years. The growth of Internet markets where public and private organizations can sell their IPOs of corporate stock to investors has been particularly spectacular. The first phase of cyber-trading started in early 1999 with the advent of partial distribution of shares directly to investors via the Internet. Now, the transition has made the actual determination of offer price as well as allocation of shares a machine-accessible process.

           In the traditional IPO process, investment bank acted as an intermediary between the sellers and buyers. The seller was the issuing firm and the buyers consisted typically of large investors. The investment bank was obliged to perform various services such as pricing the stock, forming syndicates of investment banks to distribute shares and providing access specially to large investors to ease distribution. It assessed interest in the stock and took preliminary subscriptions from shares. These information were used by the bank to determine the price and number of shares to sell. The investment bank used to charge a fee (commission) for this service usually based on the amount of money raised.

           The type of service provided by online investment banks differ chiefly in the functioning of the intermediary. This has become more efficient as the digitization of services has reduced transaction costs. Their initial role includes providing market access, price discovery and informing a trustworthy investor. Then the online investment banks carry out final price determination through a negotiation and ultimately selling it to the highest bidder. This helps an individual investor to invest in a company when it first raises capital from public. Bids are taken for a few weeks and after that the offering price is fixed at the floor level so that all the shares can be sold. An investor with a bid above the offer price can get as many shares as he wishes upto a limit of 10% of the shares sold.

           Although the underlying mechanics of IPO has remained more or less intact, the whole process sails more transparently. The disintermediation process has extenuated the desirability for brokerage. Both the offer price and investors are determined by market.

Reasons for taking the online route:

  • It is justifiable to know more about the firms that choose to distribute a portion of their IPOs through the online investment bank route. Findings show that the online investment banks employed by the Internet IPOs are more reputed than those used by traditional distribution methods. Also their CEOs are significantly younger.

  • Internet IPOs have larger market value than those distributed by traditional distribution methods.

  • The firms that go public via the traditional distribution methods miss out a lot of money. This is because conventionally the investment banks bought the entire offering and under priced it by 15-20% below the estimated market value. This helped them make a quick profit. Also they had a huge 7% (non-negotiable) fee for carrying out the whole process. Online investment banks have revolutionized the unfair IPO game. They charge a fee of 4-5% as against the egregious 7% and the procedure of selling th IPO is also a lot fairer. A computer ranks the bids submitted by investors for a fixed number of shares and then the shares are allocated to the highest bidders . This helps the market, not the investment banks to set the prices.

  • Online investment banking helps to prevent 'spinning' i.e. allocating shares to favored or potential customers thus precluding the average investor from some securities of his interest. Spinning was practiced by traditional investment banks to win future business from large institutional investors.

  • It is imperative that firms employ esteemed online investment banks. This is because people have more faith on online IPOs distributed via eminent banks.

  • E-auction by online investment banks lowers the cost of investors to obtain information about the reputability of the company issuing shares and the price of shares. Also a tech-savvy investor can go through all the IPOs available in the market and select his preferred mix quickly. Creating an electronic market place has thus reduced the cost and enhanced the quality of information.

There is a game of risk and return in every process. Since the new online procedure of issuing securities is relatively new and is yet unseasoned, firms must compare the risks associated and the benefits of a potential capital appreciation. So firms must decide before using the services of online investment banks.



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