An Initial Public Offering, or 'IPO', refers to the process of a private company offering its shares on a publicly traded exchange. Also referred to as 'taking the company public', this process allows a corporation to raise capital by making shares in the company available to public investors.
The first ever modern IPO is credited to the Dutch East India Company which made its shares available for public sale in 1602. Since then, thousands of companies have gone public.
Apple, Microsoft, Tesla, and so many more of the biggest names on Wall Street all went public at some point, which is why we are able to invest in them now.
The first step in taking the company public is through underwriting due diligence, where a third-party individual or financial institution -- such as Wells Fargo or Goldman Sachs -- assumes a portion of the company's financial risk when going public. If the IPO goes well, they will also take a part of the profit. Underwriting involves conducting research and assessing the degree of risk of each applicant or entity before assuming that risk.
The company must then meet the requirements of the Securities and Exchange Commission (SEC) as well as the exchange they wish to list on, whether it be Nasdaq or the New York Stock Exchange. An S-1 Registration statement is the primary IPO filing document and contains the company's prospectus -- information on its path to profitability and how much it will grow, almost like a 5-year plan -- and its privately held filing information.
Before going public, the companies 'price per share' must then be determined. This can be done in one of two ways:
1. The company and its leading managers fix a price itself in what is known as a 'fixed price offering', meaning investors know the price before the company goes public.
2. Otherwise, the price can be determined through analysis of confidential investor demand data compiled by the bookrunner, known as 'book building'.
Then, a board of directors must be formed and a process established for the company to report auditable financial and accounting information every quarter. After that it's all about picking a date to go public.
As we know, there are other ways to take a company public such as a 'direct listing', which is when the company is taken public without any underwriters. This means that the company going public and issuing the shares assumes all the risk. There is also the lesser-known 'Dutch Auction', where shares literally go to the highest bidder. Google did this in 2004 in lieu of a traditional IPO and it worked out ok for them.
So what are the advantages of a traditional IPO?
It's not all sunshine and rainbows though, as seen by some disappointing IPO performances in recent years, which included Uber, Lyft, and SmileDirectClub.
What is the purpose of an IPO?
The purpose of an IPO is to raise money from outsiders in a manner that provides the funders with a predefined and very limited set of rights.
How does an IPO make money?
A bank or group of banks put up the money to fund the IPO and 'buys' the shares of the company before they are actually listed on a stock exchange.
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