IPO – Initial Public Offering
New York Stock Exchange
Definition: An IPO, or Initial Public Offering, is the first public sale of stock in a company.
A corporation does not need to be publicly traded, and, in fact, most are not. They are used, primarily, to act as a liability buffer between the people who are doing work and the clients for whom they work. Additionally, they can be used to borrow money from all the same sources that an individual can – but the shareholders’ assets are not held against the loan. There are also many taxation benefits, varying from region to region, to using a corporation.
At some point, however, a company may want to acquire additional capital, often in order to expand their markets and operations, or to launch new products. There are several ways that the companies can raise this capital, for example, borrowing the funds from a bank, or getting a cash infusion from a large investor. The result, however, may be at the cost of debt, or a significant portion of equity and control that the current owners of the corporation may not want to take on.
Usually, when stocks are traded on the market, the funds are exchanged between the two investors involved in the trade. During an IPO, however, money paid for stocks is given to the company issuing the stock. A third party called an underwriting firm may be used to assist in the sale of the stocks, and they will take a percentage of the proceeds of the sale.
For this reason, issuing new shares to sell on the public market can be extremely beneficial to the company, as they can acquire large sums of cash (typically in the millions of dollars for a successful IPO) at a predictable rate. While they may have difficulty in setting the correct price on their shares, as long as they don’t overprice the shares too much, they can often count on a failry large infusion of cash for a controlled amount of equity.
Existing shareholders in the company generally welcome an IPO (and, in fact, many hope for the day the company goes public) as it gives a real value to their holdings. For example, if the three founders of the company owns 1 million shares each in the company, when the company goes public, issuing an additional 1 million shares, while they are [usually] not allowed to sell their shares for a certain amount of time after the IPO, they now know how much their shares are worth in real dollars.
Which brings up another point. There are a lot of regulations surrounding these public offerings, and who can trade what, and when. There are, at the time of the offering, few statistics about the company making the offer, meaning that investing in such a company can be extremely risky. Not only that, but the company is not allowed to make certain types of releases around the time of the offering in terms of research.
While an IPO can quickly bring in large amounts of investment at a relatively low cost, as well as provide initial shareholders with a return on their holdings, they are, in most cases, extremely risky for the new investors.
Thanks to @momoesque for the topic suggestion.
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