Info about IPOs
Initial Public Offerings explained
An IPO is a method of raising finance used by many businesses when they have grown to a sufficient level. Also known as ‘floating’, it is the first time that a company issues its stock to the public, and represents a significant stage in the growth of a firm.
A company may choose to offer its shares on the stock market for a number of reasons. The main and by far the most common motive for listing shares for sale in an IPO is to attract cash inflow from investors. In contrast with stock sales after the shares have been listed on the market, cash paid by investors during an IPO is received directly by the company. This allows the company to build large amounts of capital quickly for future growth. IPOs have an advantage over other methods of raising finance, such as Bond issues, as they are never required to pay back the capital received. However, in return for their investment, investors receive ownership of an equity stake in the business, relative to the amount they put in. As well as raising a level of initial finance, an IPO also offers company the advantage of being able to list additional shares for sale at a future date. This allows the firm to grow without taking on debt, or having to pitch and discuss deals with individual investors.
Outside of raising additional capital, IPOs offer other advantages for the listing firm. By floating shares on the stock market, businesses become Public Corporation, which gives them a larger amount of prestige than being a privately owned business or partnership. This prestige is a key benefit as it allows the company to attract more skilled and experienced staff, as well as increasing their reputation with suppliers and customers alike. Banks are also more likely to give cheaper rates of interest to a public company, as public companies are traditionally much better for repaying loans than privately owned businesses.
In order to carry out an IPO, the firm that wishes to list its shares may take on the services of an investment bank, known as an underwriter. The underwriter agrees to take legal responsibility for the offered shares, and approaches investors to sell them to. There are a number of different methods which can be utilized by an underwriter in order to sell shares, which vary depending on the type of contract signed. They include a firm commitment contract, a Dutch auction and a best efforts contract, amongst others. The underwriters make their money by charging a commission for the selling of shares. In cases where several underwriters sell shares for an IPO, the lead underwriter- the investment bank selling the largest number of shares, takes the largest commission.
The prices at which the shares are sold are determined by the issuing firm’s managers. They meet and discuss various factors such as the worth of the company’s assets and the risks associated with various debts. Another method which can be used is the process of book-building; however it is far more common for the managers to fix the share price.