Initial public offering (IPO)

Page written by AI. Reviewed internally on July 1, 2024.

Definition

An IPO, or initial public offering, is a significant financial event that marks the first time a private company offers its shares to the public on a stock exchange.

What is an initial public offering?

When a company decides to go public through an IPO, it typically means that it has reached a stage of growth where it requires additional capital to fund its expansion, research, development, or other business activities. Going public also provides the company’s founders and early investors an opportunity to cash out some of their investments.

Before launching an IPO, the company needs to go through a thorough preparation process. This involves working with investment banks, lawyers, and financial experts to assess the company’s financials, valuation, market positioning, and regulatory compliance.

The company, along with its underwriting investment banks, determines the initial price at which its shares will be offered to the public. This price is often based on factors such as the company’s financial performance, industry trends, and market demand.

Prior to the IPO, the company may engage in a roadshow, which involves presentations to potential investors to generate interest and educate them about the company’s business model, growth prospects, and financials.

Once the IPO shares are priced and allocated to investors, the company’s shares are listed on a stock exchange. This allows investors to buy and sell shares of the company’s stock in the secondary market.

As a publicly traded company, the company is subject to regulatory requirements, including regular financial reporting and disclosure of material events. This level of transparency is designed to provide investors with accurate and up-to-date information about the company’s performance and outlook.

Alternatives to initial public offering

IPO is not the only option. Alternatives are:

Direct listing

A direct listing refers to an IPO conducted without underwriters. By skipping the underwriting process, the issuer assumes greater risk if the offering underperforms, yet may potentially benefit from a higher share price. This approach is typically viable for companies with established brands and attractive business prospects.

Dutch auction

In a Dutch auction IPO, the price of shares is not predetermined. Instead, potential buyers submit bids indicating both the quantity of shares desired and the price they are willing to pay. Shares are then allocated to bidders offering the highest prices until all available shares are allocated.

Example of initial public offering

YZ Tech Inc., a successful technology startup, has been operating as a private company, raising funds from venture capital and private investors. They decide to go public to raise additional capital for expansion, research and development, and to provide liquidity for existing shareholders.

Based on investor interest and market conditions, the offering price for XYZ Tech Inc.’s shares is determined. The underwriters allocate shares to institutional investors and individual investors.

On the day of the IPO, the company’s shares are officially available for trading on the stock exchange. The opening price is often different from the offering price, depending on market demand.

XYZ Tech Inc. successfully raises capital through the sale of its shares in the IPO. The funds raised can be used for various purposes, such as expansion, acquisitions, or debt repayment.

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