Going public, or taking a company public, means making it possible for outside investors to buy the company’s stock. Selling shares gives the company’s owners access to more capital than they can raise elsewhere and, unlike a loan, never has to be repaid.
Initial public offering (IPO) process
The initial public offering (IPO) process traditionally begins when a company that wants to be publicly traded contacts an underwriting firm, usually an investment bank. The underwriter agrees to buy all the public shares at a set price and resell them to the public. The risk the underwriter assumes is
offset by the fee it charges, usually a percentage of each share’s price. If the IPO is successful, those fees are the underwriter’s profit.
A company raises money only when its stock is issued. All subsequent trading in the stock means a profit or loss for stockholders, but not for the company.
The underwriters and the company prepare a prospectus that is filed with the Securities and Exchange Commission (SEC) and made available to potential investors as a way to assess the potential strengths of the company and the risks that investing in it may pose.
The SEC must approve the offering before it can proceed.
Just as it may issue additional shares, a company may choose to repurchase, or buy back, shares of its stock, either gradually in the stock market or by tender offer, giving shareholders the right to sell at a specific price. The company’s motive may be to boost its stock price or to reduce dilution that results from granting stock options. Or it may decide a buyback is a better use of extra cash if it thinks the market undervalues its stock.
Direct public offering (DPO)
Some companies may prefer a direct public offering (DPO). In this case, shares are offered directly to the public with the anticipation of raising capital but without using underwriters to help create a market for the stock. This approach is significantly simpler and cheaper than a traditional IPO. companies using a DPO are typically exempt from having to register with the SEC because they’re raising only a limited amount of money or offering shares exclusively to accredited investors. An accredited investor is an individual or institution that meets the net worth or annual income standards set by the SEC.
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Price of issue
The proposed stock sale is publicized in a traveling roadshow — sometimes described as a dog and pony show — designed to have the company’s managers build a buzz among stock analysts and institutional investors. The enthusiasm they are able to generate often determines how successful the launch will be.
The day before the actual sale, underwriters price the issue, or establish the price at which it will be offered to investors. Everyone who buys shares in the IPO pays that price. When the stock begins trading the next day, the price can rise or fall, depending on whether investors agree or disagree with the underwriters’ valuation of the new company.
How you invest
When an IPO comes to market, shares are available through brokers affiliated with the chief underwriter or a firm that’s part of the selling syndicate working with the underwriter. In most cases, though, the shares go to the broker’s best clients — those with the biggest accounts, the longest history, or some other advantage. You can buy shares as soon as trading begins. However, there may be good reasons to wait at least six months until the first analysts’ reports are available. Despite the buzz they may create, many IPOs trade at lower prices than comparably sized companies for several years after issue.
Listed or unlisted stocks
After an IPO, companies that meet the listing requirements of a national securities exchange — including market capitalization and net worth – typically choose to list their stock. This means investors can buy and sell shares easily in what is known as the secondary market. Unlisted stocks may be traded in the over-the-counter (OTC) market. But trading may be less liquid, and information about some stocks may be limited.
Other stocks, including some issued in a DPO, may be nontraded. This means investors should expect to hold them for extended periods and may not be able to sell even if they need the money. Some nontraded stocks are registered with the SEC though others are not.
If a company has already issued shares but wants to raise additional capital, or money, through the sale of more stock, the process is called a secondary offering. Companies are often wary of issuing more stock since the larger the supply of stock outstanding, the less valuable each share already issued may be.
For this reason, a company may issue new shares when its stock price is relatively high. As an alternative way to raise money, it may decide to issue bonds, or sometimes convertible bonds or preferred stock.
Initial Public Offering (IPO) Definition and Process by Inna Rosputnia
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