January 1st, 2010 | 
Author: An initial public offering (IPO) is the sale of equity usually in the form of common shares by a company through an investment banking firm. These shares are then listed on a recognized stock exchange where they are bought and sold.
An IPO can be made by a start-up or an established company. A start-up needs to convince potential investors that it can be a profitable enterprise by generating consistent sales and profit growth. Established companies need to establish that they will continue to grow in terms of sales and profits. Funds raised through an IPO can be used for financing an expansion of manufacturing or service or marketing capacity. They can also be used for long-term working capital purposes.
An IPO is the most expensive way to raise finance for a company. Costs can go up to 20% of the issue size. Greater the issue size, lower will be the costs per share. The costs include underwriting fees, issue management fees, costs related to the prospectus, legal fees, advertising costs.
Why do companies go public?
- An IPO is the only way a company can list its shares on the stock exchange.
- Since the company will be under public scrutiny, it can raise money from financial institutions at better interest rates.
- Promoters of these companies can become millionaires or even billionaires overnight. Take Google for example. The net worth of the two founders shot up to $7 billion after it went public.
- As long as there is good demand for the company’s stock, it can issue more shares. This makes mergers and acquisitions (M & A) easier as stocks can be offered. In the M & A market quite often you will find all stock deals.
- Listing of shares on a recognized stock exchange lends liquidity to the stock. This makes schemes such as employee stock options attractive, which help to attract and retain top talent.
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