Initial public offerings (IPO) are a common tool for companies to raise capital. By opening up to public investment, a company can bring in significant funds that can be used for various activities. The funds raised in an IPO are known as IPO proceeds.
Companies can use the capital brought in through an IPO in a variety of ways, but they must disclose their plans to investors. Read on to learn more about the definition of IPO proceeds and the uses for IPO proceeds.
IPO Proceeds Defined
When a company holds an initial public offering (IPO) they must publish their plans for how they will use the proceeds. This helps investors understand how the company will use their money, and decide whether they agree with the company’s plans before they invest.
Companies preparing for an IPO file an S-1, a several-hundred page document, with the Securities and Exchange Commission (SEC) including a disclosure about the planned use of IPO proceeds. They must also show investors a business plan. Potential investors can evaluate the business plan and see if they think they will receive a satisfactory return on their investment if they buy stock in that IPO.
While companies get to keep most of their IPO proceeds, a portion also goes to all investment banks, accountants, lawyers, and others who helped them with the IPO process, including valuing the company and setting an IPO cutoff price. According to PWC, underwriting fees alone eat up 3.5% to 7% of IPO proceeds.
What Are IPO Proceeds Used For?
There are a few areas where companies tend to spend IPO proceeds. Generally companies mention multiple uses in their S-1 filings, and it may also be something that they discuss with investors during their IPO roadshow. These might include:
General Corporate Purposes
General corporate purposes is a very common area companies talk about in their use of proceeds statements. It is a broad category that covers a lot of uses such as capital expenditures, operating expenses, and working capital, and getting more money for this is a major reason that many companies go public. Companies can use this term to describe broad activities without going into detail about their plans.
This allows them to keep their plans private and also lets them keep their options open and decide exactly how to spend money at a later date. Some companies do go into greater detail about the meaning of their general corporate purposes statement.
Research & Development
Companies might also use proceeds from an IPO to fund research and development. They spend funds developing new products and services, which can take years and significant amounts of money. Since R&D is so expensive, it is a major reason companies choose to hold IPOs.
Without R&D, some companies might struggle to keep up with competition and stay relevant in their industry. Some companies go into detail about the types of R&D projects they plan to work on using IPO proceeds, while others keep their plans vague.
Company Growth
Companies often choose to hold an IPO to raise funds for company growth. Company growth plans often appear in their business plan, and can include capital expenditures, working capital, sales and marketing plans to help a company grow its reach and revenue.
Companies want to create long-term, sustainable growth so that a company can stay in business for a long time. Like other uses of IPO proceeds, companies may go into detail about their plans for company growth expenditures or they may keep their plans vague.
Acquisitions
Companies can use IPO proceeds to merge with or acquire other businesses, something that can be very expensive. Without holding an IPO a company might not have the funds required to complete an acquisition. Acquisitions and mergers can help a company grow their customer base, eliminate competition, and expand their product and service offerings.
When a company includes an acquisition in its S-1 filing, they must state which company they intend to acquire. If they don’t yet have a company in mind to acquire, they can just list acquisitions as one possible use of IPO proceeds. A company does not have to state the exact company they are interested in acquiring if it will harm the potential of the acquisition plan.
Some companies take a unique path to acquisitions using IPO proceeds, known as a “blank check” IPO or special purpose acquisition company (SPAC). Companies create a shell company that they take public with an IPO and then use the IPO proceeds to complete an acquisition.
Debt Repayment
Another common use of IPO proceeds is to pay off debt. By paying off any existing debts, companies no longer have interest payments, so they reduce their operating costs, and they can also gain access to more funds from loans. Although it can be beneficial to a company to pay off their debts, this use of IPO proceeds is not popular with investors.
Other uses of IPO Proceeds
In addition to the uses described above, there are many other ways companies can use IPO proceeds, including paying taxes and charitable actions.
SEC Requirements on IPO Proceeds
The SEC requires companies file a “use of proceeds” section in their S-1 IPO submission. The S-1 explains to investors the goals of the IPO and what the company plans to do following the IPO, including how they will use proceeds. Requirements for what must be included in the S-1 are fairly broad, so companies can choose how much to share with potential investors, and they have a lot of choice about how they can use IPO proceeds.
There are several specific requirements for what must be included in the S-1, a document scrutinized by investors as part of their IPO due diligence. The “use of proceeds” section must include a brief outline of how proceeds from an IPO will be used. The requirements for what the brief outline includes are broad, giving companies a lot of freedom in what they want to disclose. Companies are allowed to use broad statements about planned use of funds, such as listing the categories described above.
Later sections in the S-1 submission require companies to go into greater detail about spending plans if they plan to use funds for certain activities. Just because a company states they plan to use funds in a certain way doesn’t legally bind them to actually use the funds in that way. However, companies need to inform investors that plans may change later if that is the case.
The Takeaway
With hundreds of companies going public per year, knowing how a company is going to use its IPO proceeds is important if you’re thinking about investing in that company’s IPO. You can find that and other useful information about a planned IPO in a company’s S-1.
If you’re interested in starting to invest in IPOs, one great way is using the SoFi Invest® investing app. The online trading platform lets you research, track, and buy the latest IPO stocks coming to market each year, as well as exchange-traded funds, crypto, and stocks already on the market.
FAQ
Who gets the proceeds from an IPO?
When a company holds an IPO, they receive money from banks and institutional investors who have agreed to invest prior to the start of the IPO. The company receives proceeds from the initial sale of stock. Any money exchanged after the IPO from the sale of stock doesn’t go directly to the company.
What are secondary IPO proceeds?
Primary proceeds are those made from the initial sale of stock in an IPO. Secondary IPO proceeds are those made in the stock market following the IPO.
How does an IPO raise money?
An IPO raises money by offering shares of stock in a company to institutional and retail investors. When investors purchase those stocks, the company gets to keep the proceeds, after paying underwriters, the exchange, and others that helped with the IPO process.
Photo credit: iStock/Charday Penn
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