Initial Public Offering (IPO)

What Is Initial Public Offering (IPO)?

When a private company becomes public and offers shares to the public for the first time, it's called an IPO or initial public offering. This process allows the company to raise equity capital from public investors. For private investors, this transition can be a crucial time to fully realize their gains, as it often includes a share premium. At the same time, it opens up the opportunity for public investors to participate in the offering.

The IPO process can be divided into two parts: the pre-marketing phase and the initial public offering itself. When a company is looking to go public, it can either solicit private bids or make a public statement to generate interest. Once a company decides to move forward with an IPO, it selects underwriters to lead the process. These underwriters may work together to manage different aspects of the IPO, including due diligence, document preparation, filing, marketing, and issuance. The underwriters play a crucial role in every stage of the IPO.

How It Works

Before an IPO, a company is private and has a limited number of shareholders, including early investors like the founders, family, and friends, along with professional investors. An IPO allows a company to access a significant amount of capital, which can help it grow and expand. Typically, companies reach a stage in their growth process where they believe they are mature enough for the rigors of SEC regulations and the benefits and responsibilities to public shareholders. IPO shares are priced through underwriting due diligence, and the public market opens up a huge opportunity for millions of investors to buy shares in the company. The number of shares sold and the price for which they sell are the generating factors for the company's new shareholders' equity value.

Advantages and Disadvantages

An IPO is primarily aimed at raising capital for a business, but it comes with advantages and disadvantages. One of the significant benefits of an IPO is that it enables a company to access investment from the entire public, thus raising capital. It also increases the company's exposure, prestige, and public image, which can enhance sales and profits. Increased transparency due to quarterly reporting requirements can also help a company receive more favorable credit borrowing terms.

However, IPOs are expensive and require ongoing costs of maintaining a public company. Fluctuations in share prices can be a distraction for management, and the company must disclose financial, accounting, and other business information that could help competitors. Additionally, rigid leadership and governance by the board of directors can make it more difficult to retain good managers willing to take risks. Companies also have alternatives like soliciting bids for a buyout or remaining private.