IPO Definition

IPO stands for Initial Public Offering. An IPO is part of the process when a private company offers its first public shares.

What is an IPO?

An IPO (initial public offering) is when a company first sells shares of its stock to the public. This allows a company to raise capital from public investors. This concept is often referred to as “going public.”

How does an IPO work?

Deciding to become a publicly traded company is a big decision for any business. Prior to an IPO, a business usually has a small number of shareholders that may include early investors, such as founders, family, and friends who believed in the company when it first began. A private company may also have venture capitalists or angel investors, which are considered professional investors. 

An IPO provides a business with the opportunity to raise a lot of capital. These financial resources are generally used to help a business grow and expand.

IPO shares are priced after being carefully analyzed to determine value. Shares that are privately owned will convert to public shares and will be valued at the public share price. 

Who qualifies for an IPO?

Most companies wait until they are valued at approximately $1 billion, but this is not a hard rule. Private companies are also evaluated by other criteria—like revenue—and may qualify if they can demonstrate profitability and strong fundamentals. A company may also be compared to its competitors to determine its value and the feasibility of an IPO.

IPO Advantages

The financial draw of additional capital is the biggest IPO benefit. Companies use the additional capital for growth, expansion, market entry, research, development, debt repayment, and more. Increased public awareness often accompanies an IPO, which might lead to increased market share. Another IPO benefit for existing investors is using this step as an exit strategy for those who have helped build up the company. 

IPO Disadvantages

There are some IPO disadvantages. The process can be lengthy and expensive. It’s necessary to submit periodic financial reporting. These reports become publicly available. Costs of regulatory compliance can be high, and there are a number of rules and regulations under the Securities and Exchange Commission that must be followed. The high cost can pose problems for a small business. 

IPO Examples

Here are a few IPO examples:

• Alibaba Group IPO with $21.8 billion raised (September 2014)
• Facebook IPO with $16 billion raised (May 2012)
• General Motors IPO with $20.1 billion raised (November 2010)
• Visa IPO with $17.9 billion raised (March 2008)

These are some of the biggest IPOs in the United States, according to the Corporate Finance Institute. 

Key IPO Terms

Now that you know the IPO definition, here are some additional key terms:

• Common stock—units of ownership that entitle the holder to receive company dividends and vote on company matters. 
• Issue price—a special price offered to investors prior to an IPO’s trade on public exchanges.
• Lot size—the smallest number someone can bid for in an IPO. 
• Preliminary prospectus—a document disclosing information about the company, including business strategy, current and previous financial statements, and management information. 
• Underwriter—the investment bank that manages the offering for the business issuing the IPO. They generally determine the issue price. 

Summary

An IPO is a good idea for companies that want to increase their capital quickly and have the resources to meet all of the requirements of a publicly traded company. 

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