Home > What is a IPO (Initial Public Offering)

What is an IPO (Initial Public Offering)?

Going public

In the lifetime of a business there are several stages in which it will need additional capital in order to expand its current operations. At the very beginning of its existence it usually relies on venture capital from outside investors if the founders money is not sufficient, to the moment it has grown to such a remarkable size that it makes more sense to raise money publicly instead through private investors.

This process of raising money in public or “going public” is referred to as Initial Public Offering or IPO.

Underwriters

In order to sell shares to the public a firm needs someone familiar with the process. These specialists are usually big investment banks, such as Goldman Sachs or Morgan Stanley. The involvement of these Investment banks usually ranges from advising the firm to also underwriting the issue.
Underwriting is referred to as the process of buying the shares from the issuing firm and reselling it later to the public. For very large IPOs it is sometimes necessary to have several investment banks acting as underwriters.

Risks involved

Needless to say there are risks involved in an initial public offering.
If the investment banks end up overpricing the issue, they may end up holding the shares on their own books since they will not be able to resell them to the public.
It is therefore in the investment banks interest to buy them for less than what they imagine to be able to sell them for to the public.

The companies issuing the shares on the other hand are interested in selling them for as highly priced as possible. Any trading in the market after the shares have been sold to the public leave the issuing company unaffected. If the issue is therefore heavily underpriced, the company may not end up getting its real worth in the market.

An initial public offering is usually underpriced to a certain degree in order to raise the interest of investors and to minimize the risk of not being able to sell the shares on the market.

Primary, secondary and seasoned offering

The usual initial public offering is a primary offering which means that the company is raising additional capital by selling its stock to the public.

While in a primary offering money flows directly to the company, this is not the case in a secondary offering. A secondary offering usually involves early investors selling their amount of the firm's equity to outside investors. It is therefore a transaction between those two parties and does not benefit the company directly.

A seasoned offering is an issue of additional stock of a company already publicly traded.

Home > What is a IPO (Initial Public Offering)

The Residual Income Valuation Model values a company by dividing it in two imaginitative parts, the present value of all future residual incomes and the book value of all real assets.

ginnie pig