What Is an Initial Public Offering (IPO)?

An IPO, or initial public offering, is the process whereby a private company offers stock to the public at large.

🤔 Understanding an IPO

Before their IPO, a company is still considered private, and funds flow in from a relatively small pool of investors. As a private entity, companies often focus on defining their mission, building name recognition, and growing their customer base.

But when a company reaches the stage where founders believe it can adhere to SEC regulations, as well as the expectations of and legal obligations to public shareholders, it can file its intentions to go public.

Filing for an IPO signals significant changes ahead, and it’s not a short process by any means. While there are tons of nuances to navigate, there are five major milestones that every hopeful entity must hit for a successful IPO.

1. Underwriting the offering

Underwriting typically occurs six or more months before the IPO itself. The underwriter is crucial to an IPO’s success, as it’s their job to ensure that shares are sold at the set price.

Once the company selects a bank, the two institutions enter an agreement that outlines important details, such as:

  • How much money will be raised
  • The type(s) of securities issued
  • Underwriting fees

2. Regulatory filings

This process occurs at least three months before the IPO. During this time, an IPO team consisting of the lead investment banker, lawyers, accountants, SEC experts, and others assembles to hash out the details of the IPO. Typical considerations under this team’s purview include:

  • Assembling financial information
  • Noting potential areas of improvement
  • Writing off unprofitable assets
  • Seeking new executives and Board of Directors

Once the appropriate arrangements have been made, the IPO team files an S-1 registration statement with the SEC detailing information about the company and upcoming offering. It also details how the initial funds will be used, among myriad other details.

3. Approval and pricing

At this point, the SEC will investigate the company to ensure that all its ducks are in a row. If the issuing institution passes muster, the next step for the IPO team is to set a date and price the new company.

To do so, the underwriter puts together a prospectus of the hopeful company to circulate among prospective buyers. The company’s top executives can then present this data to institutions to drum up business – this is known as the “road show.” During this time, investors can submit bids for how many shares they would like to buy. The underwriter then takes investor interest into consideration when determining a prime IPO price.

In the months before the IPO, the new Board of Directors will meet to review an audit of the company’s current situation. The company will also file with its intended stock exchange(s) to list its IPO. However, bidding investors don’t learn how many shares they can buy until the day before the IPO.

4. Stabilization

This step occurs immediately after the IPO, but it’s still an important one. In the days following initial trading, the underwriter will ensure a continuing market for the stock. The goal is to keep interest high enough that the stock doesn’t fluctuate too wildly. This “quiet period” only lasts for 25 days and serves as the hand-off to the last phase of the IPO process.

5. Transition

After 25 days since the company’s IPO, the quiet period ends. The underwriter is then tasked with providing estimates about earnings, which helps investors “transition” to relying on mandated public information about the company.

What this means for you

If you’ve considered your options and decided that IPO investing is for you, be sure to evaluate the company from multiple angles. Consider:

  • Whether the company has a significant competitive edge, such as unique patents or trademarks, or particularly effective executives
  • If there’s a current or growing market for their goods or services
  • Whether you’d be comfortable purchasing the stock knowing that its shares could fall for a time
  • If you agree with the company’s mission and business plan

But most importantly, you want to make sure that the business is foundationally and fundamentally strong. Otherwise, you’re setting yourself up for future disappointments – not to mention losses.

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