When a private company first offers shares of its stock (ownership) for purchase to the general public, this is known as an initial public offering (IPO).
Goals and Reasoning
There are a few main reasons why a private company will decide to make an IPO:
– Raise expansion capital
– Monetize the investments of early private investors.
– Become a publicly traded company on a securities exchange
– Gain credibility and prestige
When a company is ready to offer shares of its stock to the public, there are a few major steps involved:
Company hires an investment bank (underwriters).
The investment bank puts together a registration statement to be filled with the SEC. This document contains information about:
– The offering
– Financial statements
– Management background
– Any legal problems
– Where the money is to be used
– Insider holdings
The SEC then requires a cooling off period, in which they investigate and make sure all material information has been disclosed.
During the cooling off period details of the proposed offering except for the offer price and the effective date are offered to potential institutional investors in the form of a document called the initial prospectus.
Once SEC approves the offering, stock price and a date is set when the stock will be offered to the public.
Finally, the shares are sold on the stock market and the money is collected from investors.
Advantages of an IPO
– Proceeds from the IPO go directly to the company and its early private investors.
– Early investors have the opportunity to cash out, selling some or all of their shares.
– A large pool of public investors provides a diverse equity (ownership) base.
– Sale of shares provides capital for growth and repayment of debt.
– An IPO provides cheaper access to capital than taking on debt.
-After the IPO, a company has new options for acquisitions, potentially using the sale of its shares.
– Going public also offers companies new financing options including: equity, convertible debt and cheaper bank loans.
– A company going public carries a great deal of exposure, prestige and enhanced public image. This attracts better employees and management.
– Even if the company fails. It is not responsible to pay back their investment, they must sell their shares at market price.
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