What Is An IPO?


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The ultimate rite of passage for a young company is to sell its share to the public through an Initial Public Offering (IPO). When a company “goes public,” it usually means allowing its share to trade on a recognized stock exchange, such as New York Stock Exchange. In the U.S., most Internet-related IPOs trade on the National Association of Securities Dealers Automated Quotation System ( NASDAQ).

The major advantage of an IPO is that it provides a growing company with access to a huge investor pool. It also puts a lot of money into the hands of the company’s original owners, which may include venture capitalist who invested money in the fledgling company for a share of its stock. A publicly traded company also has the advantage of instant credibility with banks, creditors, and customer-and lofty post-IPO stock prices allow a company to use its own shares to finance further expansion or acquire other companies.

Being publicly quoted company also has its downside. After an IPO, a company has to publish accounting statements quarterly, forcing it to pay attention to demanding investors who often insist on looking at quarterly earnings instead of concentrating on long-term growth. Going public also requires disclosures of all relevant financial information, including the compensation of company officers, so competitors to get a free look at the inner workings of the company. And the cost of going public is not substantial: investment banks often keep up to seven percent of the IPO’s proceeds.

The path that a company takes to issuing its share to the public involves several stages. The first is to choose an investment bank, or group of investment banks, to oversee, or “underwrite” the new issue. This process is often referred to as alike baker at a county fair, to tout their skills at pricing and selling millions of shares to be offered to the public. An IPO’s underwriters are also usually responsible for buying up any unsold share.

In the United States, every IPO has to be registered with the Securities and Exchange Commission (SEC), which requires companies to prepare a “prospectus” providing an in-depth description of the company’s activities and all relevant financial figures. The preliminary prospectus has been approved, it is posted by the SEC on its.

Once the company is ready to make the plunge, the shares’ price is fixed, usually after an extensive “road show” to explain the company to potential investors and gauge market interest. Settings the new shares’ price involves a mixture of black magic and market savvy since there is no sure way of knowing what a company-especially one that has yet to show the profit is really worth. IPO share prices are often deliberately set low to generate market enthusiasm and ensure that all the shares are placed on the opening day of sale. During the late 1990s, for example, many IPOs saw their share price double or quadruple on the first day of trading, making for a lot of happy investors-especially those were able to get their shares at the fixed issue price.

The first in line to get IPO shares are so-called friends and family that the SEC allows a company to declare as “insiders”. The next in line are the big institutional investors and fund managers that form the backbone of the underwriters’ client base. The remaining shares are distributed, on a lottery basis, to the individual investors who subscribed for IPO share at all, many investors prefer to buy shares in mutual funds that invest in IPOs or in recently issued IPO stocks

Companies often prefer an IPO to sell out quickly, which guarantees that later issues of shares, called secondary offerings find a ready and willing investor pool. Usually, investors who made a lot of money on the IPO market or through secondary offerings-even when the share price has gone up considerably. When 3com spun off “Palm,” for example, only about 5 percent of Palm shares were offered to the public through IPO, which ended up generating enormous unmet demand- 3com shrewdly held back the rest of the shares to sell to the public at a later date.

Once, only a few firms stood a chance of going public. Now, it seems, almost any company can do it: restaurants, celebrities- even many companies that don’t have a profit insight. Many big companies have also used IPOs to “spin-off” smaller subsidiary to the public. In several former communist countries-Hungary and Poland, for example-IPOs have been very useful vehicles for putting state-owned companies into the public’s hands and putting large amounts of cash into the government’s pocket.

Even Individuals-including Martha Stewart, Tommy Hilfiger, Dick Clark, and Dr. Everett Koop- have used IPOs to sell shares in their enterprises to the public. Like most IPOs, the price of many of these companies’ shares has been extremely volatile, with some rising to spectacular heights only to fail sharply when promised profits failed to materialize.


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