An initial public offering (IPO) is a form of equity financing and refers to the first time a company sells shares publicly. The transition from a private to a public company can be an important time for private investors to realize gains from their investment and generally includes a share premium for current private investors. This is usually an important moment for a company—a step a company may take to when it is healthy, growing, and wants to increase its growth but cannot raise enough money privately to do so.
Typically an IPO comes after a company has reached a certain stage in its growth process when it believes it is ready for the rigors of SEC regulations, in the United States, and the benefits and responsibilities to public shareholders. Private companies will decide to take a company public at various valuations, so long as the company has strong fundamentals and proven profitability potential. That said, many private companies strive for a valuation of $1 billion or more and achieving a "unicorn" status, which can drive increased interest in the IPO and greater equity from the initial public sale.
IPOs are also held because they often reward equity holders in the company. This means executives, employees, investors, and others with equity in the company can sell their holdings, often after a six-month period after the stock is publicly traded, which is used to help stabilize the stock price during the IPO period. However, the drawbacks to going public include adhering to SEC reporting requirements, issuing regular disclosure statements, releasing financial results, conducting quarterly earnings, having fiduciary responsibilities to their shareholders, and satisfying the demands of their shareholders as well.
As in many parts of the world of investing, initial public offerings have specialized jargon, with key terms to an IPO including:
Key IPO Terms
This refers to units of ownership in a public company that entitle holders to vote on company matters and receive company dividends. These are the shares offered when a company goes public.
This refers to the price at which shares of common stock will be sold to investors before an IPO company begins trading on public exchanges; this is also commonly referred to as the offering price.
The lot size is the smallest number of shares an investor can bid for in an IPO, with larger share bids often needing to be bid in multiples of the lot size.
This is a document the IPO company issues to disclose information about the business, its strategy, historical financial statements, recent financial results, and management, and often it has red lettering down the left side of the front cover.
This refers to the price range in which investors can bid for IPO shares which are set by the company and underwriters. The price band is generally different for each category of investors.
Although the term IPO has been a popular term for a while, the Dutch are credited with conducting the first modern IPO when they offered shares of the Dutch East India Company to the general public. Since then, IPOs have been used as a way for companies to raise capital from public investors through the issuance of the public share ownership. There have been many uptrends and downtrends since, such as the famous dot-com boom, which saw startups without revenue rushing to list themselves on the stock market. In a reverse of that trend, in 2008, following the financial crisis, there were the fewest number of IPOs and they almost stopped, and in the following years, new listings remained rare. Since then, one of the latest trends, as mentioned above, is the focus on "unicorn" companies, which involve heavy speculation on the part of media and investors.
Once a company decides they want to go public, they often begin by hiring an investment bank, or banks, to handle the IPO. Once this investment bank is hired, everyone involved in the IPO, such as the management team, auditors, accountants, the underwriting banks, lawyers, and SEC experts, who attend meetings to discuss offerings and determine the timing of the filing. These meetings take place through out the policy.
As part of these meetings, due diligence is required to make sure the company's registration statements are accurate. These include market due diligence, legal and IP due diligence, and financial and tax due diligence. This due diligence process results in an S-1 Registration Statement which includes historical financial statements, key data, company overview, and risk factors, among others. This report is then filed while a pre-market is conducted to determine whether institutional investors like sector and company and the price they would be willing to pay per share. This, in part, determines the price range for the offering set by the banks, and the S-1 Registration Statement is amended with the price range.
Once this work is done, the management team tends to travel around to meet with investors and market the company. This is considered an important step to determine and develop interest in the company, which can further revise the price range. After this, the management team will meet the investment banks to decide on the price of the deal based on the orders; if there are a lot of orders, or if it is oversubscribed, the company can price the shares higher. This prices the IPO, the investment bank will allocate shares to investors, and the stock will start trading on the market for the public to buy and sell.
Initial Public Offering - an overview | ScienceDirect Topics
Initial Public Offering (IPO)
November 23, 2003
Initial Public Offering (IPO)
IPO Meaning: What Does IPO Stand For?
January 19, 2018
What Is An IPO?
August 25, 2021