IPO (Initial Public Offering) Explained
An Initial Public Offering or IPO is an important and crucial stock market event that should interest investors, traders, and business owners.
But what is an IPO, how do you prepare for it as a trader, and what else should you know about this substantial event? Here’s all you need to know about IPOs:
Definition and Purpose of an IPO
Initial Public Offering (IPO) is when a private company becomes publicly traded. In other words, when an IPO happens, companies that were once private offer their shares to the public, hence allowing the company to secure investments from public investors.
The Significance of Going Public
Going public is important for various reasons. Here are the main ones:
It helps companies raise more capital: As IPOs grant companies access to public investors, they enable the augmentation of capital. This, in turn, can be utilized for debt repayment and investment in research and development (R&D).
It provides existing investors with higher liquidity and easier exit points: Taking a company’s shares public and pricing them at a more affordable price can increase liquidity, hence allowing private shareowners to swiftly sell their stakes with minimal transaction fees.
It increases brand awareness and improves a company’s perception: As companies list on a reputable stock exchange, their brand awareness grows, and the perception of the company improves.
It assures the company’s partners and contractors: Becoming a public company can provide a company’s contractors and existing partners with more assurance regarding the company’s financial stability and growth outlook, thus providing them with a solid foundation for business terms and relationships.
Famous IPOs: IPOs Throughout History
From the first-ever IPO to some of the most notable IPOs, here are some of the famous IPOs throughout history:
The Dutch East India Co.
The Dutch East India Co. is known for being the world’s first IPO. This company was established in 1602 in the Dutch Republic and was issued for public trading on the Amsterdam Stock Exchange. The company, which is now defunct, went public on August 1602 and specialized in trade and was among the biggest European trading companies of its time.
Alibaba Group
Chinese multinational e-commerce and tech giant, Alibaba (BABA) was established in 1999 and went public on September 18, 2014. Among Alibaba’s most famous business segments are Aliexpress, an e-commerce company, Youku, a Chinese video platform, and Freshhippo, a retail chain. Alibaba’s IPO raised $21.8 billion and was deemed among the biggest IPOs of all time.
Softbank Corp
Softbank Corp. (9984.TY) is a Japanese, Tokyo-based, multinational investment company that was founded in 1981 and went public on December 10, 2018. Softbank is known for providing communication services and mobile devices and its IPO raised $21.3 billion.
Visa
Visa (V) is an American financial services company specializing in payment services, debit, and credit cards. The company was founded in 1958, went public on March 18, 2008, and raised $17.4 billion during its IPO.
Facebook (Meta Platforms)
Formerly known as Facebook, Meta Platforms (META) is a tech company known for its social media platforms founded in 2004, and became a public company on May 17, 2012. Meta’s IPO raised $16 billion.
General Motors
General Motors (GM) is a Michigan-based automotive company that was founded in 1908 and went public on November 17, 2010.
Preparing For an IPO
Although IPOs do have their perks and may sound intriguing to many business owners, there are a few steps that must be taken and some considerations to keep in mind before deciding to go public. Here are some:
Is Going Public the Right Choice?
Before going public, it is important to know whether or not the company in question is actually ready to take such an important step. As such, business owners should ask themselves if going public is the right choice for their company and whether or not the timing is right for such a step.
Legal and Regulatory Requirements
Becoming a public company demands undergoing regulatory constraints. In addition, legal fees are very pricy which means that companies need to have enough capital before undergoing an IPO.
Assembling the IPO Team
A crucial aspect of a successful IPO is having the right IPO team. In other words, before going public business owners need to ensure that they have the right personnel and leadership to operate a public company.
The IPO Process (Life Cycle)
An IPO is an extensive process that can take from months to a year to complete. Here are the main events that take place before an IPO is completed on a US stock exchange:
Selecting an Investment Bank
The first step of an IPO is choosing an investment bank based on criteria such as reputation, research quality, industry expertise, distribution capabilities, and prior relationships.
Making the Underwriting Agreements
After selecting an investment bank, the underwriting agreements should be made as the investment bank acts as an intermediate between the company and the public investors. This step involves choosing an underwriting arrangement that includes Firm Commitment and Best Efforts among other agreements, and drafting essential documents like an Engagement Letter and Letter of Intent.
Filing with the Securities and Exchange Commission (SEC)
In order to become publicly traded, the issuing company must get approved by the Securities and Exchange Commission (SEC).
Determining the IPO Pricing
Once the SEC approves the issuance of the company, the effective date is established. Following that, the company and its underwriter price the companies’ shares and decide the quantity that will be sold.
Providing After-Market Stabilization
After the company is launched in the market, the underwriter must provide analyst recommendations and create a market for the issued stock. This process is called “after-market stabilization.”
Shifting to Competitive Markets
Finally, upon completing the aforementioned procedures, subsequent to a 25-day SEC-mandated "quiet period.” At this time, investors stop depending on the required documents and start looking at how the market is doing to learn about their shares. Once the 25 days pass, underwriters can give their opinions on how much money the company is making and its overall value.
The IPO Day
The IPO Day is the day when the issuing company’s shares become officially part of the stock market and become publicly traded on a stock exchange. This monumental event begins as retail and institutional investors start to buy and sell the newly listed shares.
Post-IPO Life
Once the company’s shares become publicly traded, the company must execute its plans and work to deliver its goals. This is a prolonged phase that aims to show the company’s long-term strength in the market and includes challenges such as navigating market volatility, unwanted price swings, or investor relations. Other hurdles that a publicly traded company must face post-IPO include stringent regulatory compliance, maintaining shareholder confidence, adverse market swings, and rising market competition. (Source: Investopedia)
Conclusion
To conclude, an IPO is a crucial event in the stock market and should interest analysts, investors, and business owners. Such an event can provide companies with the potential for increased capital and market liquidity. Nonetheless, despite the many potential benefits an IPO holds, it also comes with many challenges that the issuing companies must face.
IPO FAQs
What is an IPO and why do companies go public?
An Initial Public Offering (IPO) refers to when private companies become publicly traded. The primary goals for going public may include raising more capital, becoming more liquid, and improving brand awareness.
How is the IPO price determined?
An IPO price is determined by the company and its underwrite following the company getting approved by the Securities and Exchange Commission (SEC) on the US stock exchange.
What are the risks and challenges associated with IPOs?
Some of the risks and challenges that accompany an IPO include market volatility, stringent regulatory requirements, handling changing market perceptions, and more.
Can any company go public, regardless of size?
In order for a company to go public it must comply with considerations like size, value, and financial health.
How can investors participate in an IPO?
Investors can take part in an IPO by purchasing shares of the issuing company on the stock market on the IPO day. Alternatively, they can secure shares through their brokerage firm through pre-IPO access.
