Although some on Wall Street will tell you it stands for ‘It’s Probably Overpriced’, IPO is short for Initial Public Offering. It means a company is popping its stock exchange cherry and its shares are being made available for sale to the public for the first time. That’s why they call it ‘going public’ and it’s a major milestone for any company, but you may then ask…
What makes a company decide now’s the time to go for an IPO?
These days, we keep hearing about startups that make it sound like they will be the next Facebook or the Uber of <insert service here>. Bonus points if they were conceived in a garage or a dormitory room. But technically, every company begins life as a ‘startup.’ Just like that famous expression ‘There’s a sucker born every minute’ – well, there are probably just as many companies being set up every day. (Though only a tiny fraction of them will ever make it to IPO stage!)
In this startup phase, they will try to get their business off the ground by figuring out their sweet spot in the marketplace and winning over customers. Once business starts picking up, most entrepreneurs will look for funding because they’ll need more money in the pot to finance growth. They can get this funding in many ways – from investors, a bank loan, etc.
As a matter of fact, shifting business to a higher gear – whether it’s to roll out new products or enter new markets – usually requires a lot of money. If things keep going REALLY well and the business explodes in popularity like a Bruno Mars single, then it’s a sign it may be ready for an IPO.
But why an IPO if the company’s already earning profits or getting funded, anyway?
Well, money from the original investors can now be freed up for new investments – or for a new Ferrari! But also, trading in an open market means the company can raise cash more quickly and more easily. On the day of its IPO back in 2012, Facebook set a record with 460 million shares traded, raising a total of $16 billion! Imagine how many investors’ asses Zuckerberg would have to kiss to raise that amount of capital.
It’s also less risky since the company isn’t reliant on just a few shareholders or investors. What if one of them dropped dead or went bankrupt?!
In addition, company stock can be used like currency because anything that can be bought and sold has value. For instance, a company can use it to negotiate deals with companies it’s trying to acquire.
Finally, a company is seen as legit when it’s listed on the stock exchange. Too legit to quit, as MC Hammer would say. After all, public companies have nowhere to hide their skeletons since they now have to disclose their accounts (though there will always be a few that try to cook the books, of course). As a result, securing financing may become even cheaper and easier – they may get lower interest rates on bank loans, for instance.
What happens once a company has had its IPO?
The founders cash in and live happily ever after…
If a company is listed on the stock exchange, then there will usually be new shares issued and sold to the general public. That could be regular folk like you and me, but also institutional investors like banks, insurers and pension funds. Then everyone can trade those shares on the stock market. The money that the business gets from those new shares is then used for further growth. Then it’s up to the company whether it wants to share a cut of its future profits with shareholders through dividends.
All views, opinions and analyzes in this article should not be read as personal investment advice and individual investors should make their own decisions or seek independent advice. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication.