Initial public offering facts for kids

An initial public offering (often called an IPO) is when a private company first offers its shares to the public. This means anyone can buy a small piece of the company. It's like a company saying, "Hey, we're growing, and we want more people to join us by owning a part of our business!" When a company does an IPO, it changes from being owned by a few people to being owned by many public investors.

What is an IPO?

An IPO is a special event where a company sells its shares for the very first time. These shares are sold to big investors (like banks) and also to everyday people. Usually, expert financial companies called "investment banks" help the company with this process. They also help list the shares on a stock exchange, which is a marketplace where shares are bought and sold. This whole process is sometimes called "going public."

Why Companies Go Public

Companies decide to go public for several reasons:

• To raise money: They can get new money from investors to help their business grow, pay off debts, or fund new projects.
• For early investors: People who invested in the company when it was private (like the founders) can sell some of their shares and turn their investment into cash.
• Easier trading: Once a company is public, its shares can be easily bought and sold by anyone, making it simpler for people to invest in or sell their part of the company.

When a company goes public, the money from new shares can go directly to the company. It can also go to early investors who choose to sell some of their shares. An IPO helps a company connect with many potential investors. This gives the company the money it needs for future growth.

How Shares are Traded After an IPO

After an IPO, the company's shares are traded freely in the open market. This is known as the free float. This means people can buy and sell them every day. Stock exchanges have rules about how many shares must be available for public trading.

Even though IPOs offer many good things, they also have costs. These include fees for banks and lawyers. Public companies also need to share important information about their business regularly. This information can sometimes be private.

Companies share details about their planned IPO in a long document called a prospectus. Most companies get help from an investment bank to manage their IPO. These banks help figure out the right price for the shares. They also help create a market for the shares to be sold.

A Look Back: History of IPOs

The idea of public shares is very old! Some historians believe the earliest form was in ancient Rome. Companies called publicani issued shares. These shares were like parts of the company. There is evidence that these shares were sold to the public. They were traded in the Forum, a central marketplace. The value of these shares changed, which encouraged people to buy and sell them.

In the United States, the first IPO happened around 1783. It was for the Bank of North America.

How an IPO Works: The Steps

IPO procedures are governed by different laws in different countries. For example, in the United States, the United States Securities and Exchange Commission (SEC) sets the rules. In the United Kingdom, the UK Listing Authority handles this.

Getting Ready for an IPO

Planning is very important for a successful IPO. Here are some general steps a company takes:

• Build a strong team of leaders and experts.
• Grow the business with the goal of becoming a public company.
• Prepare official financial reports that follow specific rules.
• Make sure the company's operations are clear and well-organized.
• Set up good ways to manage the company.

Working with Investment Banks

Most IPOs involve one or more investment banks. These banks are called "underwriters." The company selling its shares (the "issuer") works with a lead underwriter. This underwriter helps sell its shares to the public. They reach out to investors with offers to sell those shares.

A large IPO is usually handled by a group of investment banks. This group is called a "syndicate." The biggest bank in the group is the "lead underwriter." When the shares are sold, the underwriters keep a part of the money as their fee. This fee is called an underwriting spread.

Multinational IPOs may have many syndicates. This is because different countries have different legal rules. The lead underwriter usually leads all these groups.

Because of all the legal rules and costs, IPOs also involve law firms. These firms specialize in securities law.

Interestingly, before 1860, many early U.S. companies sold shares directly to the public. They did not use investment banks. This was called a direct public offering (DPO). The company itself set the share price.

Selling and Pricing the Shares

Shares in an IPO can be sold in different ways. They are sold to both large investors and individual customers of the banks. A licensed salesperson selling IPO shares to clients is paid a portion of the selling fee.

The company often gives the underwriters an option to sell up to 15% more shares. This is called a greenshoe option. It is typically used if the IPO is very popular and many people want to buy shares.

In the U.S., potential buyers get a first draft of the prospectus. It's called a red herring prospectus. It has a red warning on the front. This warning says the information is not complete and might change. During this initial "quiet period," shares cannot be officially offered for sale. However, brokers can ask clients if they are interested. Later, when the IPO is official, these interests can become actual buy orders. Sales can only happen after the final prospectus is approved by the Securities and Exchange Commission.

The last step involves financial "printers." They print and electronically file the final prospectus with the SEC. This process often involves many meetings with lawyers, bankers, and accountants. They all make final edits and check everything.

Different Ways to Price Shares

A company planning an IPO usually picks a lead manager, called a bookrunner. This manager helps decide the right price for the shares. There are two main ways to set the price:

• Fixed price method: The company and its managers set a specific price.
• Book building: The price is decided by looking at how much investors are willing to pay.

Historically, many IPOs have been priced a bit low. This makes the stock more exciting and causes its price to rise quickly when it starts trading. This quick rise is known as an "IPO pop." Investors who sell their shares quickly for a profit are called "flippers." While this can be good for investors, it means the company might have missed out on raising more money.

However, pricing shares too high is also risky. If the price is too high, the banks might struggle to sell all the shares. Even if they do, the stock price might fall on the first day. This can make the stock less appealing and cause losses for investors. A famous example of this was the Facebook IPO in 2012.

So, banks consider many things when pricing an IPO. They try to find a price that attracts investors but also raises enough money for the company.

The "Dutch Auction" Method

A Dutch auction is a different way to sell IPO shares. In this method, all successful buyers pay the same price per share. Bids are ranked from highest to lowest. The highest bids are accepted until all shares are sold. All winning bidders then pay the lowest accepted price. This method is similar to how the U.S. government sells its bonds.

Google used the Dutch auction system for its IPO in 2004. Some traditional U.S. investment banks have not liked this method. This is because it gives everyone an equal chance to buy shares. It removes the special treatment that important clients might get in regular IPOs. Because of this, the Dutch auction is still not used very often in the U.S., but it has been used in many other countries.

Some researchers believe that Dutch auctions help find the true price of shares better. However, others argue that traditional IPOs might be safer because banks manage the process more closely.

The "Quiet Period"

Under American securities law, there are two "quiet periods" during an IPO. The first is after a company files its official papers but before the SEC approves them. During this time, the company and its team cannot talk much about the upcoming IPO. This is to make sure everyone gets the same information at the same time.

The other "quiet period" refers to a period of 10 calendar days following an IPO's first day of public trading. During this time, insiders and any underwriters involved in the IPO are restricted from issuing any earnings forecasts or research reports for the company. After this period, the banks usually start publishing research about the company.

What is "Flipping" Shares?

"Stag profit" is a term used in the stock market before and right after a company's IPO. A "stag" is an investor who buys new shares hoping the price will rise quickly. "Stag profit" is the money gained when the shares' value goes up. This term is more popular in the United Kingdom. In the U.S., these investors are often called "flippers." They get shares in the offering and then quickly sell them on the first day of trading for a profit.

Big IPOs Around the World

Many companies have raised huge amounts of money through IPOs. Here are some of the largest:

Where Most IPOs Happen

Prior to 2009, the United States was the top place for IPOs in terms of total money raised. Since then, other stock exchanges have also become very active.

See Also

In Spanish: Oferta pública de venta para niños

• Alternative public offering
• Direct public offering
• Public offering without listing
• Reverse takeover
• Smaller reporting company
• Special-purpose acquisition company
• Venture capital