What is an Initial Public Offering?

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

The Process

When a company is ready to offer shares of its stock to the public, there are a few major steps involved:

Step 1:
Company hires an investment bank (underwriters).
Step 2:
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

Step 3:
The SEC then requires a cooling off period, in which they investigate and make sure all material information has been disclosed.

Step 4:
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.

Step 5:
Once SEC approves the offering, stock price and a date is set when the stock will be offered to the public.

Step 6:
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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