What Is an IPO? How a Company Goes Public

An initial public offering, or IPO, is the first sale of a company's shares to public investors, after which they trade between investors on an exchange. The company sells shares in that offering. Every trade after it is between investors, though a listed company can issue more shares later in a follow-on offering.

This page covers what an IPO is, why a company does one, the steps from banks to first trade, who buys at the offer price, lock-ups, and the alternatives. Numbers here are invented and round. It is descriptive throughout.

What an IPO is

Before an IPO, a company is private: its shares sit with founders, employees, and backing funds, and cannot be bought on an exchange. An IPO registers a block of shares for sale to the public, sells them, and lists the company, so from then on the shares change hands at a market price that sets its market capitalisation.

Some offerings sell new shares, whose cash goes to the company, some sell existing ones held by early backers, whose cash goes to them, and many do both. After listing day the company is not a party to the trades. For a worked case, see the SpaceX IPO explainer.

Why a company goes public, and what it costs

The motives are capital and liquidity: a large sum raised at once, a market where employees and early backers can sell, and a listed price that works as a currency for acquisitions and staff awards.

The costs are permanent. The banks take a cut of the money raised, legal, audit, and listing fees are paid on top, and the company must then publish audited annual and quarterly financials and disclose material events. Kresmion's coverage of a company begins once it is public and filing, with its annual and quarterly reports, its largest institutional holders from 13F filings on the company's research page, and its insider Form 4 activity grouped into clusters.

The process, step by step

• Underwriters chosen. The lead bank, or bookrunner, organises the deal and heads a syndicate of banks that place the shares. In a firm commitment deal they buy the offering outright and resell it, which is why their cut is a discount to the offer price rather than a fee.
• Registration statement filed. In the United States this is Form S-1, lodged with the Securities and Exchange Commission and free to read on EDGAR.
• Roadshow. Management presents to institutional investors while the banks collect indications of interest: how many shares each would take, at what price.
• Pricing. The night before trading, the company and its banks set one offer price and the final deal size.
• First trade. The exchange opens the stock through an auction matching the orders arriving that morning.

Those last two steps produce two different numbers, and confusing them is a common beginner error. The offer price is negotiated by the company and its bankers; the opening trade is whatever level clears the exchange's orders. Nothing requires them to match. Underwriters also usually oversell the deal and hold an over-allotment option, the greenshoe, letting them buy up to 15 percent more shares from the company at the offer price for about a month afterwards, which is why an announced deal size can grow after pricing.

Worked example, invented figures. A company with 90 million private shares issues 10 million new ones at 20 dollars: 100 million shares outstanding, 200 million raised before fees, and a 7 percent underwriting discount leaving 186 million. At the offer price the whole company is valued at 2 billion dollars. If the first trades print at 26 dollars it is 2.6 billion; at 16 dollars, 1.6 billion.

Who actually gets shares at the offer price

Almost nobody outside the institutional channel. Underwriters allocate the offered shares to clients they choose: large asset managers, pension funds, and hedge funds. Retail access exists at some brokers, but quantities are small and orders are often cut or unfilled.

So an individual buying on listing day buys on the exchange at the market price, wherever trading has taken it. The offer price in the press went to other buyers the night before.

Lock-ups and the months after listing

Pre-IPO shareholders sign lock-up agreements: contracts with the underwriters restricting sales for a fixed window after listing, commonly around 180 days.

In the example above, 10 million shares can trade on day one and 90 million are locked. When the window closes, the locked shares become sellable, so the quantity that can reach the market rises sharply on a date printed in the filing.

Sales by officers, directors and holders of more than 10 percent must be filed on Form 4 in the United States within two business days: see the guide to Form 4 insider filings. A smaller pre-IPO backer selling out has no such obligation.

Direct listings and mergers with a blank cheque company

In a direct listing, the company registers existing shares and lists them without underwriters selling new ones. There is no allocation book, so no investor gets shares at a set offer price, and the company raises no cash: the exchange publishes a reference price and the first trade comes from the opening auction. With no underwriters there is also no lock-up agreement of the usual kind, so existing holders can sell from the first day.

A special purpose acquisition company, or SPAC, reverses the order. A shell with no business does its own IPO and the cash sits in a trust while it seeks a private company to merge with. On completion the two combine and the private owners hold listed stock. The merger is put to shareholders in a proxy statement, or a Form S-4 where new shares are issued, rather than in a fresh S-1 for the operating company. SPAC investors may redeem their shares for cash before the deal closes, so the cash delivered can be well below the amount raised.

Key takeaways

Frequently asked questions

How do I buy shares in an IPO?

Most individuals cannot buy at the offer price, because underwriters allocate those shares to institutional and selected brokerage clients. The ordinary route is an order placed on the exchange once trading opens.

What is the difference between the IPO price and the opening price?

The offer price is the one price at which the company sells shares to the investors the underwriters chose, agreed the night before trading starts. The opening price is where the exchange's first auction matches buyers and sellers the next morning.

Where can I read a company's IPO filing?

United States registration statements are filed on Form S-1 with the Securities and Exchange Commission and published free on EDGAR while the deal is pending. They carry audited financials, risk factors, the share count, and the use of proceeds.

What happens when an IPO lock-up period ends?

The restriction on pre-IPO holders expires, so shares that were unsellable become tradable, often multiplying the quantity that can reach the market. Sales by officers, directors and holders of more than 10 percent are then disclosed on Form 4.

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Source: Securities and Exchange Commission registration and disclosure rules, including Form S-1 and Form 4, exchange listing and auction rules, and standard underwriting practice. This page is information, not investment advice. Kresmion Research.