Initial Public Offerings (IPOs)

IPOs are an invaluable tool for companies to raise capital. Understanding a company’s debut on public markets is important to properly understanding how to invest in it.

Guide to IPOs

An IPO is when a company issues stock to be traded for the first time on public markets. After an IPO a company that was previously privately held becomes a publicly held one that anyone with enough money can purchase shares of.

An IPO allows a company to raise a large amount of money by selling issued shares to the general public. Far more people with far more total money can invest in public markets and so companies can generally raise significantly more money through IPOs than through private equity, in which shares are sold to specific accredited investors, not on the open market. This lets the company tap into a large amount of money that can be used to grow and improve its business, while early investors can usually make a profit by selling the shares they purchased when the company was still in its earlier stages. However, when a company goes public, they are then answerable to a much larger group of shareholders.

IPOs technically have two prices, their offering price, and opening price. The offering price is the price at which shares are sold to institutional investors and brokers just before a company begins publicly trading. The process of figuring out an offering price is called book building, and involves underwriters gauging demand for the company’s stock by soliciting bids from institutional investors. The opening price is the price shares begin trading at on an exchange and is determined by compiling the bids of investors on the exchanges.

An IPO is when a company issues new shares which an underwriter helps to sell and market. A direct listing is when a company lists existing shares on an exchange to be sold without an underwriter.

Key Terms

Pre-Initial Public Offering (IPO) Placement Initial Public Offering (IPO) Roadshow Greenshoe Option Bookbuilding Red Herring Oversubscribed Direct Listing Stabilizing Bid

A pre-IPO placement is a sale of large amounts of a company’s stock before it goes public. The shares are sold to institutional investors such as private equity firms or hedge funds, and usually at a significant discount to the IPO price. Companies do this to get some level of definite fundraising in case the IPO price is too high and demand for their stock isn’t what they expected.

An IPO is when a company issues and sells stock on public markets with the aid of an underwriter. This allows companies to access a much larger pool of capital to raise money, as everyone, not just accredited investors, can buy stock. However, the company must often pay significant underwriting fees and greatly increases reporting and transparency requirements.

Roadshows are presentations made by underwriters and company management to market an initial public offering (IPO) to prospective investors. In addition to generating attention for a stock’s IPO, roadshows can help underwriters gain information to determine the IPO price, a process known as book building.

A greenshoe option, also known as an overallotment option, is a contract provision in a company’s underwriting agreement that allows underwriters to sell more stock than the initial IPO amount. These provisions usually allow for up to 15% more shares to be sold than originally intended, and are generally invoked when there is significantly more-than-expected demand for the stock. The name “greenshoe” comes from the Green Shoe Manufacturing Company, the first firm to use this type of provision in an IPO.

Bookbuilding is the process by which underwriters determine the issue price of an initial public offering (IPO). Underwriters will request bids from institutional investors to see how much stock they want and at what price.

A red herring is an incomplete draft prospectus released by a company before an initial public offering (IPO). The red herring allows the company to let investors know it will be issuing stock, before it is sure how much stock it will issue and at what price. These prospectuses also tell investors information about the company’s operations finances. The nickname comes from the red disclaimer on these draft prospectuses indicating that it has not yet been finalized and is still subject to change.

An initial public offering (IPO) is said to be oversubscribed when the demand for its stock is greater than the number of shares it is selling. An oversubscribed offering will often invoke a greenshoe option, a provision in its underwriting contract that allows additional shares to be sold to meet demand. Other types of offerings such as debt securities can also be oversubscribed.

A direct listing, also known as a direct public offering (DPO), is an alternative way for a company to go public instead of an initial public offering (IPO). In a direct listing, a company issues no additional stock and does not hire an underwriter, it simply lists currently existing shares for sale on public markets.

A stabilizing bid is when an underwriter purchases stock following an initial public offering (IPO) in order to prop up the price of the stock. This happens when the underwriter overestimated the amount of demand for the stock.