14 Sep 2018

What is an ‘Initial Public Offering – IPO’

An initial public offering is when a private company or corporation raises investment capital by offering its stock to the public for the first time. Growing companies seeking capital to expand are those that generally use initial public offerings, but large, privately owned companies or corporations looking to become publicly traded can also do them. In an initial public offering, the issuer, or company raising capital, brings in an underwriting firm or investment bank, to help determine the best type of security to issue, offering price, amount of shares and timeframe for the market offering.

BREAKING DOWN ‘Initial Public Offering – IPO’

Some people refer to an initial public offering as a public offering. There are other ways to go public other than an initial public offering, including a direct listing or direct public offering. When a company starts the IPO process, a specific set of events occurs. The chosen underwriters facilitate these steps.

  • An external initial public offering team is formed, comprising an underwriter, lawyers, certified public accountants and Securities and Exchange Commission experts.
  • Information regarding the company is compiled, including financial performance and expected future operations. This becomes part of the company prospectus, which is circulated for review.
  • The financial statements are submitted for an official audit.
  • The company files its prospectus with the SEC and sets a date for the offering.

Example of an Initial Public Offering vs. a Direct Listing

A direct listing, such as the one completed by Spotify in 2018, occurs when a company simultaneously lists its shares on an exchange and offers ownership for the first time. Direct listings do not follow the normal capital-raising route as an IPO because direct listings do not raise additional capital for the company. In contrast, IPOs are capital raising where new equity risk capital is issued to new owners, and the firm keeps the value of the equity raise, less applicable fees, taxes and expenses.

The act of raising investment capital during an IPO is known as underwriting. Underwriting is the process of raising additional investment capital using the services of an investment bank as the underwriter. In an IPO, banks establish the market clearing price for an IPO based on an aggregate of institutional investor indications of the price they would pay for an equity allocation of the pre-IPO company.

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