initial public offering (IPO)
An initial public offering (IPO) is the event when a privately held organization initially offers stock shares in the company on a public stock exchange. The act of having an IPO is sometimes referred to as "going public," as it enables the general public to participate in trading shares in a specific company.
Ownership in a company is often calculated by dividing up the perceived value of the organization into individual shares. When a company is privately held, all the shares are held by individuals or organizations that have limited ability to trade or sell shares with other private or institutional investors. Information about share volume and price for a company that is not publicly traded does not need to be publicly disclosed.
With an IPO, shares in an organization are listed on a public stock exchange, such as the New York Stock Exchange (NYSE) or the National Association of Securities Dealers Automatic Quotation System (NASDAQ) in the U.S. When shares are initially listed on the public exchange, it is easier for both institutional and retail investors to buy and sell shares in the company. As part of an IPO, there is typically also share issuance, with a company offering new shares in the company that can be bought.
With an IPO, an organization will get a new listing on a public exchange, which includes a stock ticker symbol making it easy to identify and trade the stock. The new listing will also be tracked by the public exchange providing bid and ask prices for a stock, share volume, as well as stock high and low prices over a given timeframe, such as a day or a 52-week period.
History of IPOs
The concept and practice of publicly trading shares and having IPOs is hundreds of years old.
The first modern IPO is likely to have occurred in the early 1600s with shares in the Dutch East India Company that were offered to residents of the Netherlands. In the U.S. an IPO, and the ability to trade shares in a company publicly, is an idea that is almost as old as the country itself. The NYSE traces its roots back to 1792, with the first U.S. IPOs including the Bank of New York and the First Bank of the United States.
In the 20th century, the stock exchanges grew alongside the emergence of different communications technologies. These include the stock ticker telegraph (also known as a ticker tape), telephone and the internet.
In the technology space, IBM was publicly traded in 1911, when the company was producing business machines, such as a typewriters and scales. The 1980s was a particularly noteworthy period for technology IPOs, with many industry stalwarts going public. In March 1986, Microsoft went public with IPO share prices of $21. In the same month, Oracle went public at an initial price of $15 a share.
The dot-com bubble era of the late 1990s also led to an explosion of technology IPOs. This included Amazon in May 1997 and eBay in September 1998, with both companies initially trading at $18 a share. The dot-com era also led to numerous large IPOs for companies that ultimately failed, including Pets.com, which had its IPO in February 2000 and ended up ceasing operations in November of the same year.
In the 2020s, one of the largest software IPOs was with cloud data platform Snowflake's public offering in September 2020, in which the company raised over $3 billion.
The volume of IPOs in any given period can and will fluctuate for a number of different reasons. In times of overall economic growth, there tend to be more IPOs as investors tend to be more optimistic and willing to participate. The inverse is often true with times of high inflation, slow economic growth or other factors influencing macro-economic stability and tempering investor sentiment toward IPOs.
How does an IPO work?
The process for setting up and executing an IPO is a time- and resource-intensive activity.
Depending on the jurisdiction in which the company wants to list its shares, there can often be regulatory restrictions and requirements. In the U.S., the Securities and Exchange Commission (SEC) sets the rules and regulations that determine eligibility for a company to be publicly traded.
There are multiple foundational steps to an IPO, including:
- Strategic review. The initial step is for an organization to do a comprehensive review of operations and business goals to understand how an IPO will impact the organization.
- Engage with an underwriter. The organization will need to engage with an investment bank or group of investment banks that will serve as underwriters for the IPO. The underwriters are the ones that sell the initial block of shares, for a commission.
- Develop a prospectus. The prospectus is the document that outlines the financial status of the company and how many shares the company is looking to issue, as well as outlining the opportunities and the challenges the company will face.
- File the S-1 with the SEC. The formal prospectus document that is publicly filed in the U.S with the SEC is the S-1. When an S-1 is filed with SEC, it is commonly referred to as the point at which a company has filed for an IPO.
- Investor promotion. Companies will need to promote their IPO to potential investors, in what was once commonly referred to as an "investor roadshow."
- Share issuance. On the day the IPO occurs, there is an initial share price and the stock begins trading publicly.
For investors, there are several possible ways to invest in an IPO. Institutional investors are often able to get access directly via the underwriters to be able to purchase shares at the initial listing price. Individual investors can put in a bid or a buy order via a stockbroker or retail investing trading platform to get share in an IPO when it is available.
Performance for an IPO is often measured in the volume of shares traded and the increase in value for those shares on the day the shares are first traded. IPO performance can also be measured for any given amount of time after the date shares are first listed, in terms of share volume or price.
As part of the process of setting up the IPO, a company and its underwriters will determine a valuation for the company. Based on that expected valuation, the company -- together with its underwriters -- will determine an opening share price and share float for the number of shares that will be made available. If the price is deemed to be undervalued, investors can potentially aggressively bid up the price. The inverse is also true for shares that are deemed too expensive. It is hard to estimate the value of hype and early investor interest leading up to an IPO, which could lead to a price spike.
Determining the value of a company and what its price should be worth at IPO involves looking at the fundamentals of a company's financial performance, as listed in a company's prospectus and S-1 filing. From that data, investors can identify the expected growth rate of the company, potential risks and general outlook that will help to inform value and pricing of the stock.
Advantages and disadvantages of IPOs
There are numerous advantages for a company to have an IPO, which are as follows:
- Provides an exit, a way for early investors and company insiders to sell their equity and potentially profit. An IPO is also sometimes seen as a liquidity event, where insiders can more easily trade shares.
- Enables an organization to raise more money in the public market than might otherwise be possible through private, institutional or venture capital investors.
- Allows a company to raise capital without increasing debt.
- Raises profile of the company, with stock ticker symbol on a public exchange.
- Can be a trigger for financial analyst coverage, which can spur additional interest and valuation for a company.
The disadvantages for a company to have an IPO are as follows:
- Compliance requirements for a public company involve significant resources and cost.
- There's a requirement to publicly report earnings every quarter, which is a time-consuming exercise.
- Performance is publicly evaluated every quarter, which can lead some organizations to prioritize short-term gains to meet quarterly expectations instead of focusing on long-term growth.
Alternatives to IPOs
For organizations looking to raise capital and grow, there are several different alternatives to taking the IPO route, including the following:
Direct listing. A direct listing is an option for companies that want to be listed on a public stock exchange, rather than having an IPO where shares are offered via a syndicate of underwriters. With a direct listing, organizations can get their shares directly listed on an exchange, without going through the IPO process with underwriters. Among the technology vendors in recent years that have gone the direct listing route is Slack, which listed in 2019.
SPAC. A special purpose acquisition company (SPAC) became a popular path to the public market for companies in 2020. Among the many companies that got listed on public stock exchanges in 2020 via SPAC was data backup vendors AvePoint in November 2020. With a SPAC, an existing holding company that is already listed on a public stock exchange merges with a private company. The resulting merged company remains listed on the exchange.
Staying private. Another alternative to IPO is to just keep the company private. A privately held company can still raise money from venture capitalist and institutional investors. It has also been the case that a company that is public is taken private after an acquisition in a bid to help reorganize without the compliance scrutiny of the public markets. This was the case with Anaplan, which decided to go private after being acquired by private equity firm Thoma Bravo in March 2022.