What Is an IPO? How an IPO Works?

An initial public offering (IPO) provides companies access to capital in the public markets, which can help expand their businesses. But an IPO also comes under intense scrutiny from investors and may negatively affect brand recognition.

When companies decide to go public, they often employ underwriting banks as advisors in marketing the deal and book-building - measuring interest for shares in their offering.

Initial Public Offering (IPO)

An Initial Public Offering, or IPO, occurs when a private company first makes available shares to the public through a public stock exchange. It's a complex process; many factors influence its price; for instance, roadshows give underwriters indications of investor demand while valuation techniques include discounted cash flow valuation and comparable firms adjustments; moreover, bookrunners receive a large portion of gross spread (on a per share basis).

Businesses might seek an initial public offering (IPO) as a means to raise funds and expand their market presence, or use proceeds from an IPO to reduce debt or expand operations. Early investors in companies that go public may be subject to lockup agreements which prevent them from selling their shares until a specific date - this can cause an artificial shortage when their IPO price exceeds expectations.

Registration

An Initial Public Offering (IPO) is an essential step for any company and involves extensive preparations. Before filing with the exchange commission, businesses must carefully assess their systems, accounting policies, financial statements and legal agreements as well as finding an experienced management team with knowledge in dealing with an IPO. Once this step has been completed, businesses must file a registration statement with them.

Once an application for its initial public offering (IPO) has been accepted, a business can set a date and hire an investment bank to facilitate it. At that point, extensive financial analysis will take place by both firms and investment banks in order to value them and determine share pricing.

Investors will follow news headlines closely throughout this process; however, their primary source of information should be the prospectus provided as soon as a company files its S-1 registration. It contains valuable details regarding management team and underwriter quality - the lead underwriter responsible for selling most shares will receive both an underwriting fee and concession payment.

Pricing

Before an initial public offering (IPO), companies and their investment bankers set the price range of shares to be offered in an IPO, then ask institutional investors for bids through book building - also known as book-building - before setting an auction date and opening bids.

Underwriters allocate shares to investors they think will maintain long-term holdings of the stock and contribute to creating a liquid market. A managing or lead underwriter typically earns both fees and concessions from total share offerings, while individual broker-dealers will likely take smaller commissions.

Outside of raising money through an initial public offering (IPO), other objectives can include increasing media attention, raising visibility, and reaping dividends for venture capital firms that funded early stage development. Companies may have employee options worth cashing in during an IPO; however, be mindful that its process can often be turbulent and proceed with caution.

Trading

Companies turn public for various reasons, including raising significant sums of capital for expansion or acquisitions. Furthermore, being listed can lend more credibility and allow access to borrowed funds at more favorable terms.

When a company wants to sell shares, it typically engages one or more investment banks as lead underwriters to market its IPO and sell shares publicly. Each time shares are sold through them, they pay out fees plus transaction costs to their lead underwriter.

Investors can build interest in an IPO by following news headlines, but the primary source of information about it will be found in its prospectus (available as soon as a company files its S-1 Registration). Pay particular attention to management commentary and underwriter quality when reviewing it; also note that newly listed stocks often experience volatility on their first trading day.