What is an IPO?
The U.S. Securities and Exchange Commission defines IPO as initial public offering, the first time when a company sells its shares to the public.
It may be a young company trying to generate some needed revenue or an established company that just waited to go public. Whether a company is trying to expand or just paying its debts, the bottom line is that companies seek an IPO to raise money.
Investing in an IPO can be risky to an investor. No one can guess whether the stock will be profitable because there's not enough historical data to say how the company will perform.
Process of getting an IPO
A startup must go through specific steps in the IPO process. The steps, outlined by Investopedia, include:
The company hires an investment bank. A company goes through what is called underwriting, which is when investment bankers raise capital from investors on behalf of corporations. The investment bank acts like the middle man.
The company negotiates the deal with the investment bank. Issues to be negotiated include how much money a company wants to raise, what types of securities will be issued and how the deal will be structured. The structuring can either be a firm commitment, in which an underwriter guarantees how much will be raised, or a best efforts agreement, under which the underwriter sells securities but doesn't guarantee to the company how much will be raised.
The investment bank prepares a registration agreement. The agreement is filed with the Securities Exchange Commission. It includes financial statements, management background, any legal problems concerning the company, any legal problems faced by the company and other company information. The SEC verifies the information is correct, and then sets a date on which the stock may be offered to the public.
The underwriter releases an initial prospectus. This prospectus, released during the "cooling off period" while the SEC verifies data, builds up hype. It has most of the information about the company but not the offer price or the effective date. It's during this stage that the underwriter tries to draw in large institutional investors, while individual investors aren't sought out until later.
The company and underwriter negotiate the price. Factors in that decision include how successful the hype-building was and what condition the market is in as the effective date nears.
The investment bank sells the securities on the stock market. This is when investors collect the money.
Before you consider going public, make sure to prepare a comprehensive business plan. We offer free forms designed to help you develop your business plan.
Financial meaning of an IPO
An IPO raises needed capital to help a company grow. It's a payday of sorts to founders and investors who stand to profit. The price of the stock may even go higher between the IPO and the secondary market offering.
There are stories about entrepreneurs becoming millionaires or even billionaires after their companies went public. This isn't the case. The companies best prepared to go this route are ones that already have a solid track record and are in an industry that's already the focus of much hype.
It also is neither a cheap step for a company to go through the IPO process nor a solution for every company. If you don't have audited financials for the past few years, you may want to think of another way to raise cash. The same goes if your industry isn't on the fast track to growth. There may just not be enough interest there.
Companies must follow specific steps laid out by the federal government, both by the SEC and under the Sarbanes-Oxley Act of 2002. It can be costly to comply with all the regulations, adding up to possibly $2 million or more. If the initial public offering isn't successful, that may be money lost.
Your company will also inviting more scrutiny by the SEC and shareholders. Competitors can also get information on your company.
It's important to weigh both the pros and the cons closely before making a decision.
Cultural meaning of an IPO
It's not only about the money. A successful IPO spells out success for a company. It generates interest and can be a signal to the top talent in the industry that this company has made it. This can also be a boost to employees' pride, especially after sticking with a startup through thick and thin.
There are other disadvantages as well. The investors become part owners and get a say. Also, just like the public will take notice of a successful IPO, the public takes note of an unsuccessful one as well.
Consider these factors when deciding whether to take your company public and go through the IPO process. Before making that decision, seek out legal and financial advice based specifically on your company. We offer references to affordable legal help through our On Call attorney service.
This article contains general legal information and does not contain legal advice. Rocket Lawyer is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.