Going public, or taking a company public, involves offering the company’s stock to outside investors for the first time. This process allows the company’s owners to raise significant capital from a broader pool of investors. Unlike a loan, the capital raised from selling shares does not require repayment, providing the company with financial resources without the burden of debt.
Initial public offering (IPO) process
The initial public offering (IPO) process typically starts when a company seeking to go public engages an underwriting firm, often an investment bank. The underwriter commits to purchasing all the shares intended for public sale at a predetermined price and then reselling them to investors. The risk the underwriter takes on by guaranteeing the sale of these shares is mitigated by a fee, usually calculated as a percentage of each share’s price. If the IPO is successful, the fees collected represent the underwriter’s profit.
A company generates capital only during the initial issuance of its stock. After that, any subsequent trading of the stock on the market results in profits or losses for the shareholders, not the company itself.
The underwriters, in collaboration with the company, prepare a prospectus that is submitted to the Securities and Exchange Commission (SEC). This document is made available to potential investors to help them evaluate the company’s strengths and the risks associated with investing in it.
Before the offering can move forward, it must receive approval from the SEC.
A company may opt to repurchase, or buy back, its own shares either gradually through the stock market or via a tender offer, which gives shareholders the option to sell at a specific price. The company might be motivated to do this in order to boost its stock price, reduce dilution from stock options, or strategically use excess cash if it believes the market undervalues its stock.
Direct public offering (DPO)
Some companies may opt for a direct public offering (DPO), where shares are sold directly to the public to raise capital without involving underwriters to establish a market for the stock. This method is often simpler and less expensive than a traditional IPO. Companies choosing a DPO are usually exempt from registering with the SEC, either because they are raising a limited amount of money or because they are offering shares exclusively to accredited investors—those individuals or institutions that meet the SEC’s net worth or income requirements.
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Price of issue
The proposed stock sale is typically promoted through a traveling roadshow, often referred to as a “dog and pony show,” where the company’s managers aim to generate excitement among stock analysts and institutional investors. The level of enthusiasm they drum up can significantly influence the success of the IPO.
The day before the sale, underwriters set the issue price—the price at which the stock will be offered to investors. All buyers in the IPO purchase shares at this fixed price. When the stock begins trading the following day, its price can either rise or fall, depending on how investors perceive the underwriters’ valuation of the new company.
How you invest
When an IPO is launched, shares are typically available through brokers associated with the lead underwriter or firms within the selling syndicate collaborating with the underwriter. Often, these shares are allocated to the broker’s top clients, who may have large accounts or a long-standing relationship with the firm. While you can purchase shares as soon as trading starts, it might be wise to wait at least six months until initial analyst reports are available. Despite the initial hype, many IPOs trade below their issue prices for several years compared to similar-sized companies.
Listed or unlisted stocks
After an IPO, companies that meet the listing criteria of a national securities exchange—such as market capitalization and net worth—often choose to list their stock. This allows investors to buy and sell shares easily in the secondary market. Stocks that aren’t listed may trade in the over-the-counter (OTC) market, where liquidity might be lower and information could be less accessible.
Some stocks, including those issued through a direct public offering (DPO), may be nontraded. This means investors might need to hold these shares for extended periods and may face difficulty selling them if needed. Nontraded stocks may be registered with the SEC, but not all are.
Secondary offerings
If a company has already issued shares but wants to raise additional capital by selling more stock, this is known as a secondary offering. Companies may be cautious about issuing additional shares because increasing the supply can dilute the value of existing shares.
To mitigate this, companies often choose to issue new shares when their stock price is relatively high. Alternatively, they might opt to raise capital by issuing bonds, convertible bonds, or preferred stock, which can provide funds without diluting existing shareholders’ equity.
Initial Public Offering (IPO) Definition and Process by Inna Rosputnia
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