An initial public offering, or IPO, is when a privately owned company has shares listed for the first time on a stock exchange, allowing the general public to buy and sell shares. The process is also known as “going public.”
IPOs for high-profile companies often get a lot of media attention. If investors race to be a part of it, share prices can skyrocket. But IPOs can also be risky investments, with the potential for valuations to fall substantially.
Of course, companies hope for the former situation, since a major reason that companies go public is to raise capital. There are also a number of other benefits of going public, but there are also some disadvantages to going public. Here’s a look.
What Is a Public Company?
A public company is one with shares that trade on a public exchange, available to anyone with a brokerage account.
Public companies must register with the Securities and Exchange Commission (SEC) disclose certain information about their business practices and finances to the public regularly. For example, the company must complete a Form 10-K to report annual audited financial statements and a share discussion of the company’s business results.
The company must also make quarterly reports on Form 10-Q, which reports unaudited financial statements and allows readers to see a comparison of a current quarter’s results with the same quarter in a previous year.
Private companies do not have to disclose this information and can keep the details of their business dealings secret.
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Why Companies Go Public
To the public at large, an IPO means the first chance to invest in a specific company. Those investments can help the company raise capital, and provide an opportunity for early investors in the company to cash out if they want to, recouping their investment and hopefully making a profit.
Here’s a closer look at some of the reasons an unlisted company might go public.
Raise Capital
One of the main reasons private companies offer shares to the public on the open market is to raise capital. Prior to an Initial Public Offering, companies often have to rely on private investors, bank loans, or venture capital to raise money, all of which can be expensive. An IPO is also expensive, but over the long run it may be a cheaper way to raise large amounts of money, which the company can use to grow, fund research and development or pay down debts.
Gain Publicity
IPOs are also a great way to drum up publicity for a company. When a company announces that it will go public, it may generate significant press coverage. Before a stock even hits the market, news outlets may discuss what they know about a company’s fundamentals, its value, and whether they think the anticipated initial stock price is fair.
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After the IPO, companies may remain in the news cycle as pundits track public opinion and stock price. An IPO can confer on a company a certain standing in the eyes of the public and institutions, such as large banks, which could help it as it seeks out credit or looks for business partners.
Liquidity
An IPO is what is known as a “liquidity event.” It’s a chance for company founders and early investors to take illiquid assets, such as an investment in a private company, and turn them into cash, monetizing their investments by selling their shares.
There are typically some temporary guardrails that keep early investors from selling immediately, namely, the “lock-up” period. Usually in place for 90 to 180 days after an IPO, the lock-up is a time during which early investors are not allowed to sell their shares. That’s because founders or other early investors in a company may own more shares than are available in the IPO.
If they sell immediately, they may flood the market with those shares, potentially driving down the price. The lock-up period prevents this and helps ensure that share prices remain relatively stable for a period of time after the IPO.
Exit Strategy
Another term that is used to describe the process of liquidating assets during an IPO is an exit strategy. Exit strategies are plans businesses, investors and venture capitalists might put in place to allow them to exit their position in a certain asset and realize a profit once it meets a set of criteria.
The Benefits and Disadvantages of Going Public
The decision to IPO comes with certain advantages and drawbacks.
| Pros | Cons |
|---|---|
| An IPO may allow a company to raise capital on a scale otherwise unavailable to it. It can use these funds to expand the business, build infrastructure, and to fund research and development. | Public companies must keep the public informed about their business operations and finance. They are subject to a host of filing requirements from the SEC, from initial disclosure obligations to quarterly and annual financial reports. |
| After an IPO, companies can issue more stock, which can help with future efforts to raise capital. | Companies and company leaders may be liable if legal obligations like quarterly and annual filings aren’t met. |
| IPOs increase liquidity, which allows business owners and employees to more easily exercise stock options or sell shares. | Public companies must consider the concerns and opinions of a potentially vast pool of investors. Private companies on the other hand, often answer to only a small group of owners and investors. |
| Public companies may use stock as payment when acquiring or merging with other businesses. | Public companies are under more scrutiny than their private counterparts, as they’re forced to disclose information about their business operations. |
| IPOs can generate a lot of publicity. | Going public is time consuming and expensive. |
The Process of Becoming a Public Company
Before a company is listed for the first time on an exchange, there are a number of IPO requirements it must meet. The company must follow a complicated IPO process, involving legal and operational legwork, which can take six months to a year, or even longer to complete.
1. Choosing an underwriter: The company must choose an IPO underwriter, an investment bank registered with the SEC to offer this service. Underwriters act as a broker between the company and the investing public.
2. Due diligence: The underwriter will conduct background research on the company and its management. They want to ensure there are no surprises that might affect the IPO. The underwriter will begin the registration process with the SEC.
3. Review and road show: The SEC will review the documents. At the same time, the company and its underwriter will prepare for the “road show” during which they’ll gauge interest in the IPO from institutional investors.
4. Pricing: When the SEC approves the IPO, the company will set an initial share price.
5. Launch: When the number of shares and price has been set, the company can list its stock on the market.
6. Stabilization: After launch, the underwriter will work to execute trades that will influence pricing in favor of the company. The SEC allows this during the first 25 days of an IPO.
7. Transition to market competition: Once that 25-day period is up, market
The Takeaway
IPOs have many benefits for both companies and investors. Before you invest in an IPO, take some time to learn about it by looking at the documents the company files as part of the IPO process.
To buy shares after an IPO, you’ll need to open a brokerage account and execute trades online or over the phone. One great way to start is by opening a brokerage account on the SoFi Invest investment app, which allows you to invest in IPOs along with stocks, exchange-traded funds.
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Investing in an Initial Public Offering (IPO) involves substantial risk, including the risk of loss. Further, there are a variety of risk factors to consider when investing in an IPO, including but not limited to, unproven management, significant debt, and lack of operating history. For a comprehensive discussion of these risks please refer to SoFi Securities’ IPO Risk Disclosure Statement. IPOs offered through SoFi Securities are not a recommendation and investors should carefully read the offering prospectus to determine whether an offering is consistent with their investment objectives, risk tolerance, and financial situation.
New offerings generally have high demand and there are a limited number of shares available for distribution to participants. Many customers may not be allocated shares and share allocations may be significantly smaller than the shares requested in the customer’s initial offer (Indication of Interest). For SoFi’s allocation procedures please refer to IPO Allocation Procedures.
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