By Aniket Bose. Edited by Arjun Chandrasekar.
An initial public offering (IPO) refers to the process of providing shares of a private corporation to the public through issuing new stocks. The issuing of these public shares allows companies to raise capital from public investors. The transition from a private company to a public company can prove to be a very important time for private investors to capitalize on gains and earn profits on their initial investments, while also giving public investors the opportunities to invest in private companies. Companies must meet certain requirements to go IPO, which are set by the Securities and Exchange Commission’s (SEC).
How does an IPO Work?
Before setting up an IPO, those companies are considered to be private. As a private company, the business has grown with a moderately small number of shareholders consisting of early investors like the family, founders, and friends, and private investors such as venture capitalists and angel investors. When companies reach a certain stage in their growth process where they believe they have matured enough to deal with the regulations set by the SEC along with the benefits and responsibilities it provides to their shareholders, they will begin advertising the companies’ interest in going public.
Usually, this certain growth for private companies occurs when the company has reached a valuation of approximately $1 billion, which is also known as “unicorn status”. At the same time, private companies at various valuations with strong fundamentals and proven profitability potential may also qualify for an IPO, depending on their market competition and ability to meet the listing requirements. An IPO is a big step for a company since it provides the company with multiple opportunities to raise a lot of capital plus a higher ability to grow and expand themselves in the industry. The increased transparency and share listing credibility can also be a factor assisting in obtaining better terms when companies are seeking to borrow funds as well. IPO shares of a company are priced upon due diligence from the company’s board of directors. When a company decides to go public, the previously owned private shares ownership converts to public ownership, and the existing private shareholder’s shares become the worth of the public trading price.
The underwriting of shares can also include special provisions for private share ownership to public share ownership. Commonly, the transition from a private to a public company is a key time for private investors to cash in and earn the returns they were expecting to make a profit. Private shareholders typically tend to hold onto their shares in the public market or sell some or even all of them for profit. The public market opens up a massive opportunity for millions of investors to buy shares in a company and contribute capital towards a company’s shareholder’s equity.
Overall, the number of shares that a company sells and the price for which the shares sell are the main factors for a company’s new shareholders’ equity value. The equity of the shareholders still represents the shares owned by investors when it is both a private company and a public company, but with an IPO the shareholders’ equity significantly increases with cash as its primary issuance. The public market consists of any individual or institutional investor that is interested to invest in any public company.