What is the IPO and How Does a Company Go Public?
IPO stands for Initial Public Offering. An IPO is done when a privately owned company wants to sell a portion of it to public investors. Through this process the company is transformed from a privately owned to a company owned by public investors.
There are several reasons for IPOs, yet the main reason is to raise money by selling shares thanks to expectations of a future profit and success. This money can be used for paying debts, upgrading, expanding, monetizing the investments of private investors.
Hiring an Investment Banker
The first step in the IPO process a company has to do is negotiate a sale of its stock to an investment banker or several bankers that act as an underwriter for the offering. Underwriters are sort of middlemen between the company and public investors. They either guarantee that a specific amount of money will be raised by selling the stock to the public or, in case of a best efforts agreement, they sell the stock without guaranteeing the sum of money raised. Obviously, underwriters work for a commission, which is usually between 5 and 7%.
The next step is that the underwriter prepares what is called the red herring prospectus. This prospectus is filed with the Securities and Exchange Commission and contains all the information about the company except for the offer price, amount and the effective date.
The Road Show
When the prospectus is finished, the underwriters take the company on a road show also known as the dog and pony show to present the company to major institutional investors across the country.
The road show gives institutions a quick presentation on the company's plans and the opportunity to ask questions. This all is done to attempt to hype and build up interest for the issue.
Depending on the success of the road show, market conditions and other factors, the underwriter and the company decide on the price.
Closing the Deal, Selling the Shares
On the day of the IPO, when the investment banker has made sure of selling all of the shares, the deal closes. The shares are purchased from the company by the investment bankers. The price paid is the IPO price minus the underwriter's commission.
After the initial public offering, the stocks begin trading at the open stock market at prices set by market forces.