Initial Public Offering (IPO)
What is an initial public offering (IPO)?
What does ‘IPO’ stand for? The definition of IPO is as follows: an initial public offering, also known as an IPO or ‘going public’, is the process of offering shares of a private organisation to the public on a stock exchange for the first time.
In an IPO, the company raising capital, typically referred to as an issuer, turns to investment banks or underwriting firms to get help in determining the type of security to issue, the number of shares and their price, as well as the time frame for the market offering.
All the details regarding the proposed offering are disclosed to potential buyers in the form of a document known as a prospectus. After the initial public offering, shares traded freely in the open market are known as the free float.
Whilst going public comes with many advantages, there are also considerable costs involved, mainly those associated with the IPO process itself (e.g. legal and banking fees). Additionally, not all companies are ready to follow the ongoing requirement to disclose important and sometimes rather sensitive information, including financial and accounting data.
Where have you heard about an initial public offering?
If someone in the news is talking about a company going public, they are referring to an initial public offering. You will typically hear investors and traders talk about the upcoming IPO of a business and whether investors should consider buying its shares.
What you need to know about an initial public offering.
Now that you know the definition of an IPO, we can look further into the details.
The first IPO took place much earlier than you might have thought, happening well before the creation of the first stock exchange in 1779. In 1602, the Dutch East India Company was formed to protect the Dutch government’s trade routes and establish a trade monopoly in the Indian Ocean. To fund their voyages, they sold shares of the company to several investors. The company paid an annual dividend, ranging between 12% and 63%, to its shareholders. This was the blueprint for the first modern IPO. In modern times, IPOs have become a favoured instrument of both investors and entrepreneurs to raise capital and get bigger market exposure.
Before going public, the company is considered to be private, with a relatively small number of shareholders mainly made up of early investors, including the founders, and professional investors, such as angel investors and venture capitalists. The term “public” refers to everybody else, including institutional and individual investors, interested in buying shares of the company. Until the company lists its stock on the exchange, the public is unable to invest in it.
Being listed on a major stock exchange brings the company a significant amount of fame and prestige. Historically, only companies with proven profitability potential and strong fundamentals could qualify for an IPO, and yet it wasn't easy to get their shares listed. Today, with a large number of stock exchanges and an increased competition between them, listing requirements have loosened up a bit.
Typically, most of the private companies are small to medium size businesses. However, you can still find some world-renowned giants which aren’t public. Good examples of these are EY, IKEA, Mars Candy, Deloitte, Reyes Holdings, Hallmark Cards and Publix Supermarkets.
Privately held companies, however, do have some benefits that are typically lost after an IPO. For example, an owner of the private business doesn’t have to disclose much information about the company’s financial or business matters.
On the contrary, public companies are subject to strict rules and regulations defined by the national authorities. They have hundreds or thousands of shareholders and must form a board of directors. All the financial and accounting data must be reported quarterly. In the US, for instance, public companies must report to the Securities and Exchange Commission (SEC). Elsewhere, they are usually supervised by governing bodies similar to the SEC. Additionally, public companies must adhere to the requirements and regulations determined by the stock exchanges where their shares are listed.
Going public brings a great amount of the much-needed capital for the company. Growing businesses that need funding will frequently use IPOs to raise money for their development and expansion. Other more established firms may use an IPO as a way to allow the inside shareholders to exit their ownership by selling shares to the public. Some companies will conduct an IPO because of the prestige and credibility it comes with.
An initial public offering is considered to be a great vehicle for investors to diversify their investment portfolios and participate in value-creating entrepreneurship. When a new company goes public, many investors, as well as traders, get excited about the chance to make more money overnight – if the stock takes off.
Until 2009, the US was the leading issuer of initial public offerings in terms of the total value. However, ever since then, China – through its stock exchanges in Shenzhen, Shanghai and Hong Kong – has been the leading issuer, raising $73 billion up to the end of November 2011. In 2011, the Hong Kong Stock Exchange raised nearly $30.9 billion as the top course for the third year in a row, while New York raised $30.7 billion.
India is also emerging as a leading IPO market worldwide: in 2017, it saw 153 IPOs hitting the Indian stock market and raising over $11.6 billion. In 2018, the Hong Kong Stock Exchange reclaimed its IPO crown again, listing 125 companies and raising over $36.5 billion. The same year, the New York Stock Exchange had 64 IPOs, raising $28.9 billion and accounting for 13.9% of the global IPO market.
To find more information about initial public offerings, check out this free online course provided by Capital.com.