An initial public offering, or IPO, is the first sale of stock by a company to the public. A company can raise money by issuing either debt or equity. If the company has never issued equity to the public, it's known as an IPO.
Companies fall into two broad categories: private and public.
A privately held company has fewer shareholders and its owners don't have to disclose much information about the company. Anybody can go out and incorporate a company: just put in some money, file the right legal documents and follow the reporting rules of your jurisdiction. Most small businesses are privately held. But large companies can be private too. Did you know that IKEA, Domino's Pizza and Hallmark Cards are all privately held?
It usually isn't possible to buy shares in a private company. You can approach the owners about investing, but they're not obligated to sell you anything. Public companies, on the other hand, have sold at least a portion of themselves to the public and trade on a stock exchange. This is why doing an IPO is also referred to as "going public."
Public companies have thousands of shareholders and are subject to strict rules and regulations. They must have a board of directors and they must report financial information every quarter. In the United States, public companies report to the Securities and Exchange Commission (SEC). In other countries, public companies are overseen by governing bodies similar to the SEC. From an investor's standpoint, the most exciting thing about a public company is that the stock is traded in the open market, like any other commodity. If you have the cash, you can invest. The CEO could hate your guts, but there's nothing he or she could do to stop you from buying stock.
Why Go Public?
Going public raises cash, and usually a lot of it. Being publicly traded also opens many financial doors:
- Because of the increased scrutiny, public companies can usually get better rates when they issue debt.
- As long as there is market demand, a public company can always issue more stock. Thus, mergers and acquisitions are easier to do because stock can be issued as part of the deal.
- Trading in the open markets means liquidity. This makes it possible to implement things like employee stock ownership plans, which help to attract top talent.
Being on a major stock exchange carries a considerable amount of prestige. In the past, only private companies with strong fundamentals could qualify for an IPO and it wasn't easy to get listed.
The internet boom changed all this. Firms no longer needed strong financials and a solid history to go public. Instead, IPOs were done by smaller startups seeking to expand their businesses. There's nothing wrong with wanting to expand, but most of these firms had never made a profit and didn't plan on being profitable any time soon. Founded on venture capital funding, they spent like Texans trying to generate enough excitement to make it to the market before burning through all their cash. In cases like this, companies might be suspected of doing an IPO just to make the founders rich. This is known as an exit strategy, implying that there's no desire to stick around and create value for shareholders. The IPO then becomes the end of the road rather than the beginning.
How can this happen? Remember: an IPO is just selling stock. It's all about the sales job. If you can convince people to buy stock in your company, you can raise a lot of money.
InvestingA public company has sold stock to the public through an initial public offering (IPO) and that stock is currently traded on a public stock exchange.
InvestingMany private companies prefer to stay private and find alternate sources of capital. Find out what firms have to gain by eschewing the windfall from a flashy IPO.
InvestingLearn why private companies are waiting longer to have their IPOs. Understand why it may be more advantageous for a company to stay private.
InvestingA privately held company is owned by its founder, management or a group of private investors.
InvestingInitial public offerings aren't the best option for every company. Consider these factors before "going public."
MarketsTaking a company public isn't easy. Here's what you need to know to make sure you and your firm are prepared for the realities of being a public entity.
Entrepreneurship & Small BusinessTaking your company public or staying private? Doing an IPO is costly and time-consuming; it also means you now have stockholders to answer to.
Managing WealthSmall companies looking for growth often use an initial public offering to raise capital. But going public brings both advantages and disadvantages.
MarketsThere's much more to going public than getting a pile of cash to grow your company. Here's how to tell if you're ready for everything an IPO entails.
MarketsRead on to learn more about the nature of stocks and the true meaning of ownership.