An Initial Public Offering (IPO) is the process in which a company decides to offer shares of stocks in the organization for the first time on a securities exchange, such as the NASDAQ stock exchange or New York Stock Exchange, to generate capital. Private companies usually collaborate with an investment banking company to represent them as the underwriter. An underwriter assesses the value of the stock and brings sellers and buyers together for public sale of the shares.
The company needs to gather all the relevant details of the IPO in a document known as a prospectus, which allows the potential buyers to see the important information about the company such as its business model, its financial position and performance and details about the company’s directors and executives. The underwriter presents the prospectus to potential buyers. Buyers will then assess the document and decide if they will participate in the purchase of stock.
Determine the Price
The underwriter and the company set the price of the initial stock offering by determining their own price or by establishing the amount that investors are willing to pay based on the information they have reviewed in the prospectus. The underwriter plays a vital role in negotiating the right value of the stock between the seller and buyer. Also, the underwriter usually ensures that the price of the stock is low to maintain demand when the stock reaches the public stock exchange. Nonetheless, it’s very important that the company avoid underpricing the stock, as it might lose capital from the initial trade.
Raise the Capital
A company sells shares of stock as a way of raising capital to expand its business and maintain its operation. Unlike issuing debt through bonds or borrowing funds from banks, a company has no obligation to reimburse buyers of its shares. This allows it to repay its debts, increase its working capital and generate more cash for the expansion and growth of the company. The IPO is also a way for private equity firms, venture capital firms or other investors in the company to be monetized for their investments. After the initial public offering, the secondary market investors usually trade the shares of stocks. At this point, a company typically carries out a “follow-on” offering, a process in which companies provide additional common stock to the public. When the company completes the IPO and becomes publicly traded, it is obliged to file an audited financial statement with the Securities and Exchange Commission (SEC) each year.
IPOs can have the attraction of an instant profit for investors. For instance, at the height of the United States’ dot-com bubble, IPO investors suddenly became rich just hours after IPOs reached public exchange. Nonetheless, the burst of the bubble emphasizes the risk of IPOs. The prices of IPOs can also be tremendously inflated over the stock’s actual value. This inflation can be very hard to maintain, leading the prices of IPO stock to drop quickly if the company doesn’t follow through with large profits.
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