An initial public offering (IPO) is the financial process where a private company sells its shares to the general public for the first time.
The mechanics of an initial public offering
A private company typically initiates an IPO to raise capital for expansion or to allow early investors to cash out their ownership stakes. Before this process, the company is owned by its founders and a small group of private investors. The transition to a public company means the firm’s shares become available for anyone to buy and sell on a public stock exchange, such as the London Stock Exchange or the Tokyo Stock Exchange.
To execute an IPO, the company hires an investment bank to underwrite the stock issuance. The underwriter evaluates the company’s financials to determine the initial price of the shares and the total number of shares to offer. The underwriter then buys these shares from the company and sells them to institutional and retail investors. During this preparation phase, the company must register with the relevant national financial regulatory authority. This regulator requires the company to disclose detailed financial information and potential risks associated with the business.
Once the initial public offering is complete, the shares trade freely on the open market. The share price fluctuates based on market demand. Public companies face strict reporting requirements. They must publish regular financial statements to maintain transparency for shareholders.
Example
Savannah Trunk Logistics is a private transportation firm that employs trained elephants to move heavy timber across difficult terrain. The founders want to expand their operations and purchase larger wildlife reserves for their working elephants. To raise the necessary funds, the company decides to go public. Savannah Trunk Logistics hires a bank to underwrite an IPO. The bank prices the shares at 20 EUR each, and the company issues two million shares. Fellow Elephants looking to add agricultural logistics to their portfolios buy these newly issued shares through their brokerage accounts. Savannah Trunk Logistics receives the raised capital minus the underwriting fees, and the shares begin trading on the public exchange the following morning.