An Initial Public Offering or IPO is the initial or introductory sale of a company’s stocks to the general public. All business entities have some form of ownership of stocks. Based on ownership, business entities fall under two categories: private and public.
Private companies are usually small businesses both in terms of capital and number of owners. They are called private mainly because the ownership is composed of an exclusive group of people. Because it is owned by a small and exclusive group, it is also able to keep most of its information closed to public scrutiny. Single proprietorship and family corporations fall under private companies. Private companies do not have an IPO because they are not controlled publicly.
Public companies, on the other hand, are usually large both in terms of capital and number of owners. As the term implies, ownership of a public company is open to the public. This ownership is done in the form of buying stocks or shares of the public company.
Most public companies start out as private companies. When a private company decides that it needs to have a large influx of capital in order to expand, one of the options is to open the company to the public and sell stocks. The first set of stocks the company offers for sale to the public is the Initial Public Offering (IPO); sometimes referred to as “going public.”
Becoming a public company
This means that the company will now trade its stock on the stock exchange of the company’s country of operation. Although it is possible for a company to convert from private to public by selling shares on its own, this very, very rarely occurs. Instead, the company usually goes through an investment bank and the following steps.
Step #1 Underwriting. Finding an investment bank to partner with is the first step a private company has to take in order to start the IPO. In most cases, several investment banks will handle the IPO, with one of them taking the lead responsibility. This is done so that the funding as well as the risk will be diluted. Several banks will submit bids on handling the IPO, stating how much capital the company stands to gain and what the bank’s share will be. This process of an investment bank handling the IPO is called underwriting.
Step #2 Getting Approval. After a deal is made between the company going public and the investment bank, the bank files a registration statement with the Securities and Exchange Commission (SEC), a part of the U.S. federal government. This is composed of pertinent information on the company, which includes the company’s management setup, financial statement, history, present ownership, etc.
At this point, the SEC will now make a thorough investigation of the company applying to go public. They will check to see if all the information given is true and correct. If the SEC finds that everything is in order and is satisfied with the application, the application is approved.
Step #3 Prospectus and Date. The underwriter (investment bank) will now come up with a prospectus, which is a financial background on the company. A date is also set for the IPO.
Step #4 Pricing and Selling the IPO. The company and the underwriter will then come up with an initial price for the IPO. This is usually dependent on the market’s reaction to the new stock. Many IPOs are offered initially to major investors prior to the date of listing on a stock market. Small investors wanting to buy shares will have to wait until the IPO is released on the stock exchange.
Why “go public”?
Grow business. One reason to offer an IPO is to raise capital. The money from the sale of these stocks then becomes the capital the business needs. The first set of stocks the company offers for sale to the public is the Initial Public Offering.
Exit strategy. The National Federation of Independent Business (NFIB) explains how an IPO can increase the value of your business if you are planning to sell it in the future.
Negatives. Going public is expensive, and few businesses manage to successfully launch an IPO. Keep in mind that once you go public, you may lose some flexibility with business decisions and will need to keep shareholders informed about your operation.
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