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What is an 'Initial Public Offering - IPO'

An initial public offering (IPO) is when a private company or corporation raises investment capital by offering its stock to the public for the first time. Initial public offerings are often issued by growing companies seeking capital to expand, but they can also be done by large privately owned companies or corporations looking to become publicly traded. In an initial public offering, the issuer, or company raising capital, procures the assistance of an underwriting firm or investment bank, to help determine the best type of security to issue, offering price, amount of shares and timeframe for the market offering.

BREAKING DOWN 'Initial Public Offering - IPO'

An initial public offering (IPO) is also referred to as a public offering. There are other ways to go public outside of an initial public offering, one of which is a direct listing or direct public offering (DPO). When a company initiates the IPO process, a very specific set of events occurs. The chosen underwriters facilitate all of these steps.

  • An external initial public offering team is formed, consisting of an underwriter, lawyers, certified public accountants (CPAs) and Securities and Exchange Commission (SEC) experts.
  • Information regarding the company is compiled, including financial performance and expected future operations. This becomes part of the company prospectus, which is circulated for review.
  • The financial statements are submitted for official audit.
  • The company files its prospectus with the SEC and sets a date for the offering.

Example of an Initial Public Offering (IPO) vs. a Direct Listing

A direct listing, such as the one completed by Spotify (SPOT) in 2018, occurs when a company simultaneously lists its shares on an exchange and offers ownership for the first time. Direct listings do not follow the normal capital raising route as an initial public offering as direct listings do not raise additional capital for the company. In contrast, initial public offerings are a form of capital raising where new equity risk capital is issued to new owners and the firm keeps the value of the equity raise, less applicable fees, taxes and expenses.

The act of raising investment capital (equity or debt) during an initial public offering is known as underwriting. Underwriting is the process of raising additional investment capital (equity or debt) using the services of an investment bank as the underwriter. In an initial public offering, banks establish the market clearing price for an IPO based on an aggregate of institutional investor indications of the price they would pay for an equity allocation of the pre-IPO company.

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