IPO: Definition and How It Works

IPO stands for initial public offering and refers to the first time a company sells shares on the open market. If you buy and sell shares on a public exchange, like the New York Stock Exchange (NYSE), you would have the ability to buy shares in a particular company after its IPO. For example, the social media platform Reddit had its IPO in early 2024. This means Reddit users and other investors can buy shares of the company.

Learning about IPOs and other financial terms through reputable news sources can help you develop a clear understanding of how the stock market works. This can guide your decision-making process as you choose where to invest your money. Learn more about IPOs and why companies go public.

IPO Definition

The majority of businesses operate as private companies. Each of these businesses has shareholders, or people who own part of the company. An initial public offering (IPO) is when a company opens new shares to potential investors and becomes a publicly traded entity. Anyone who wants to invest in stock exchanges can become a partial owner by buying shares. Before the IPO, the company goes through an in-depth underwriting process with an investment bank that evaluates the organization’s finances and operations.

For example, fans of European river cruises had the opportunity to buy into Viking Holdings Ltd this year. The company sold 73,647,916 shares at $24 per share.

Companies do not have to go through the IPO process to go public. They can explore the direct listing, private placement, and special purpose acquisition company (SPAC) routes. However, these options are often used by companies that have existing shares or plans to merge or expand in the future.

How Does an IPO Work?

An IPO is the process of transitioning from a privately owned company to a publicly owned one. While there is a lot of fanfare when the company reaches the stock market, the process of getting there takes months of work and planning. Companies need to be transparent about their operations and finances, both to submit reports to the Securities and Exchange Commission (SEC) and update shareholders.

Once a company goes public, this transparency remains in place. The organization will need to update shareholders on its profits and plans for the future every quarter. Instead of reporting to a handful of investors, public companies are responsible for reporting to thousands of shareholders.

IPO Process

IPOs are defined by the underwriting and road show processes, but there are a few steps in between. Here’s what needs to happen if a company plans to go public:

• Underwriting: The company hires an objective financial expert, often working for a Wall Street bank, to examine their finances in extreme detail. The underwriter will also provide an estimated value, or valuation, of the company.
• Filing: The company will submit S-1 registration forms to the SEC, which states its intent to go public.
• Form a board: The company will develop a board of directors responsible for overseeing its operations. Companies with existing boards may add additional members.
• Marketing: This is known as the “road show,” when the company promotes the IPO to encourage people to buy shares when it goes public.

Once the underwriting process is complete and the company files its necessary paperwork, it can move forward with the IPO.

Privately Owned Company vs. Public Owned Company

Most businesses are privately owned. This means the shareholders are limited to the founders, owners, and potentially a few investors. Conversely, a publicly traded company can have thousands of shareholders that buy stock in the organization. The company has to report its profits and operational strategies to anyone who owns a share.

Some companies prefer to remain private because they can operate without as much public scrutiny. They also might not need to go public or want to complete the arduous underwriting and filing processes. However, other companies believe going public is worth it. They have IPOs to raise capital and increase their overall profile, which could make them more appealing to competitors looking to acquire them in the future.

Pros of IPOs

There are several benefits of going public through an IPO if a company qualifies to file with the SEC. Here are a few reasons to do so:

• It can raise money:The entire country can buy into the company through the stock market.
• The company can raise its industry profile: It can attract new customers and partners because of the good publicity.
• An IPO can increase company profits: The profile boost can attract customers, increasing revenue.
• There is potential for improved credit: Because the organization has to be transparent in its quarterly reports, it can boost its business credit and potentially receive favorable loan terms in the future.

A company may choose to go public when it wants to be perceived as an industry leader or establish itself as a large-scale enterprise.

Cons of IPOs

Despite the benefits, there are significant drawbacks to going public. Here are a few reasons why companies might avoid this option.

• IPOs are expensive:Underwriting, filing, and marketing all cost money and need to be done while managing other operations.
• Being transparent isn’t optional:Companies need to be prepared to disclose all information about their operations and business models.
• Management can become obsessed with share prices: Small market shifts could cause management to make large organizational adjustments.

Companies that go public need to keep up with SEC reporting and regularly communicate with shareholders. This will be a complete shift from how the organization was previously run.

Why Do Companies Go Public?

Going public isn’t easy and comes with several risks. However, there are significant benefits to moving forward with an IPO. Here are a few reasons why companies go public:

• Shareholders can raise capital: When people buy into the company, the organization can fund major projects and expansion plans.
• It gives the organization a national spotlight: The company can be perceived as an industry leader and valuable enterprise.
• Improve lendability: Companies can borrow money for future projects more easily because their finances are transparent and meet SEC regulations.

Researchers found that IPOs make companies stronger by giving them more money and opportunities to work with customers, vendors, and industry leaders.

How To Buy IPO Stock

The public can buy shares in IPO stock by working with stockbrokers or using trading apps. If you are interested in an upcoming IPO and want to buy into a specific company, start using these tools before the launch date. This way you will be familiar with how stocks work before the IPO.

Some shareholders have trouble buying shares in IPOs because of the high demand for company stocks. However, as shareholders start selling and trading these stocks, you can step in to buy them.

An IPO can provide opportunities for a company to increase its profile and capital. However, the IPO process isn’t easy. It is time-consuming, expensive, and can change how companies operate day-to-day. If a company you trust goes public, you can buy shares through the IPO to show your support and potentially grow your wealth through the business’s success.