An initial public offering or IPO is a mechanism for companies to make available for the first time shares of their stock. Its purpose is to either raise capital for a new company or to fulfill a desire by an existing company to make their shares available to the public. Whether it is a new or existing company, the IPO process follows a fairly straight forward path with precise steps along the way.
The first thing a company must do before issuing stock is file a registration with the Securities and Exchange Commission (SEC.) Since the SEC has the power of nullifying any attempt to go public, a companys statement must be thoroughly accurate. Data concerning the financial health of the company must be entirely truthful. Due diligence should be the order of the day. Putting a company out onto the IPO Market is serious business. Every step in the IPO Process must be done carefully.
Sometime after, or possibly before, the registration process is done, a company will seek one or multiple investment bankers. The investment bankers will do two things for the company. First of all, they will get the companys prospectus into the hands of potential future share holders. A prospectus is a legal document that describes in detail the situation of the company. Inclusions in a prospectus are outlines of the companys market, financial statements, projections on future stock pricing and biographical information about its executives. The prospectus is sometimes called a red herring. This nickname is given because of the red ink on its cover. The red ink is a notice stamped by the SEC stating that shares cannot be bought prior to registration approval.
The second thing that an investment banker, or underwriter, does is buy the companys stock and then resell it to the public. In a so-called road show, executives from the company and the underwriters promote the stock to possible investors. This is done by meeting and going over company strategy.
In selling the shares to the underwriter, rather than directly in the marketplace (i. E. The New York Stock Exchange, ) a company does not assume market risk, it does not bear excessive promotion expense, and most importantly, it acquires its money up front. Of course, by mitigating risk and selling their stock at a fixed price to an underwriter, companies sacrifice the possibility of a higher per share price that might otherwise be generated at an exchange.
Selling to the underwriter cannot take place until registration has been approved by the SEC. Upon approval, and generally a day or so before the public offering is made, the investment banker and company executives will conclude how many shares to offer and the price per share. After all of this has taken place and the money and shares of stock are exchanged, the offering is complete.
Before deciding to buy a companys securities, underwriters do careful and complete research on that company. Prior to taking the risk, they want to be confident that the stock will sell for more than the price they paid. They face the possibility of huge profits but also the possibility of huge losses.
It goes without saying that while the risk is high for investment bankers, the IPO process offers huge potential for profit. It can be very exciting to have an opportunity to pay a low price for stock that will someday be worth a fortune.
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