Glossary

Initial Public Offering (IPO)

IPOs

Do you run a privately owned company and are looking for the next step in your business journey? Or perhaps you're looking to raise capital or boost your company's public profile? Then an IPO might be the solution your business has been looking for.

What does IPO stand for?

IPO stands for Initial Public Offering. An IPO occurs when a privately owned company lists shares on the open market. In doing so, the shares then become available for purchase by the general public. The people who then buy these shares become shareholders and become the owners of the corporation.

When a company embarks on an IPO, it's called floating or going public and a company will decide how many shares it wants to offer. An initial price for the shares will be set by an investment bank and they will base the figure on the predicted demand for them.


How does an IPO work?

The IPO process can be long and complicated, so it shouldn't be entered into lightly. The process begins when a company decides it wants to go public and sell shares. An audit must then be carried out which looks to examine all aspects of a company's financials, including its growth plans.

Once an audit has been carried out, a registration statement must be prepared and filed with the exchange commission. Depending on which stock market the company wishes to float will affect which exchange commission a statement is needed for. In the US it's the Securities and Exchange Commission (SEC) and in the UK the Financial Conduct Authority (FCA).

The registration statement is then reviewed by the chosen exchange commission, and it will either be accepted or rejected. After approval, the company must then enlist the services of an underwriter. It is their job to decide how many shares to issue and at what price.

In most circumstances, the underwriter will be an investment bank, and it is also their job to start what's known as the book-building process. This is where investors are found and these interested parties will receive a preliminary prospectus of information about the company, the shares, where they'll be listed and the potential opening list price.

An IPO is the first chance for non-private investors to buy into a company, and so it's imperative that it's done correctly. Once shares have been issued, the company's stock begins trading on the public stock exchange.


Why do companies choose an IPO?

There are many reasons why a company chooses to go public, but one of the main purposes of an initial public offering is to allow early investors in the company the chance to cash out their investment.

The majority of private businesses are established with the help of private initial investors like friends, family and angel investors, who have invested private money. An IPO allows them to sell their stake and retrieve their initial investment.

Of course, that's not always the case and an IPO is used for a number of different reasons including:

  • Allowing a company to raise additional capital to expand the business, fund research and development or pay off debt.
  • Increasing a company's public profile, which in turn can create a wider captive market.
  • Adding gravitas to a company's image, leading to securing better terms from lenders.
  • Going public could be a cheaper alternative to other ways of raising capital.

Whilst going public can be a great way for a company to raise capital and is often the next stage in a business's growth cycle, it comes with its own complications. When a company goes public there are disclosure requirements, such as filing financial reports quarterly and annually, the company must answer to its shareholders and not make decisions internally, but present ideas to a board of directors.

 

IPO FAQs

IPO terms you need to know

There's no shortage of jargon in the world of investing and whether you're considering floating your own business or you're looking at investing in shares, there are some key terms you should know. 

  • Common stock: Units of ownership – in this case, shares. Typically, they entitle holders to vote on company matters and receive company dividends.
  • Issue price: The price the shares are listed at before an IPO company begins trading. The issue price is based on an audit and an underwriter's prediction on how well the stock will perform. Commonly referred to as the offering price.
  • Lot size: The smallest number of shares you can bid for. If you're looking to invest in more shares, then you must bid on multiple lots.
  • Preliminary prospectus: A portfolio put together about the company. It details all the information about the business, including its strategy, financials and management structure.
  • Price band: The price bracket in which investors can bid for shares. The price band is set by the company and underwriter. Different investor types tend to have different categories. For example, professional buyers might have a different price band compared with retail investors like the general public.
  • Underwriter: Usually an investment bank that manages the public offering. The underwriter determines the issue price, creates the preliminary prospectus, publicises and finds investors, and then assigns shares to investors. 


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How long is the IPO process?

There is no one set duration for the IPO process, and as such, it can vary greatly depending on several factors including how it's being managed and coordinated. Often the most time-consuming stage of the IPO process is the initial audit stage, especially if a company's financials aren't in order. 

What are the advantages and disadvantages of an IPO?

Like any business decision, deciding to embark on the IPO process should not be taken lightly. With both advantages and disadvantages to becoming a public company.

Advantages

  • A successful IPO can raise large amounts of capital
  • Can help increase exposure and public image
  • A company's sales and profits can increase
  • Beneficial to traders because it's easier to buy publicly traded shares

Disadvantages

  • Public companies are subject to the rules and regulations of a governing body
  • Must disclose financial records, including accounting information, tax and profits
  • The IPO process costs a significant amount
  • Diluted ownership
  • No guarantee of success
  • Trading or investing in IPO shares is often deemed riskier than other investments due to the unpredictability of a new listing


How does an IPO raise money for a company?

Before embarking on the IPO process a business must first ascertain how much capital it wishes to raise as this will impact the number of shares it sells and the share price. When a company is floated on the stock market, investors buy the shares.

The company will only get money at the IPO, which is why it's important that the IPO price is as high as possible. The aim of an IPO is to maximise the value of the stock to shareholders, not to sell as many shares as possible. 

Can a small company go for an IPO?

Yes. Any private company can go public, however, because of the inherent risk to investors, it's suggested that a company have at least some existing track record for success before embarking on the IPO process.

Equally, the risks to companies with no revenue are much greater, and the added financial cost of the IPO process itself, as well as financial scrutiny of a business, can add to the already great pressure start-ups often face. 

What are the alternatives for raising capital?

If you're still unsure if an IPO is right for your business, there are a number of different alternatives for raising capital.

Debt: If you don't want to give up equity, but you require capital, taking out debt can be a great alternative. We offer a variety of short-term business growth loans that are perfect for when you need an extra injection of cash.

Joint venture / strategic alliance: Offering a great alternative to an IPO, joint ventures / strategic alliances offer founders the chance to raise capital without giving up control. A joint venture (JV) is a separate entity from both businesses, and both parties agree to share all profits, losses, assets, liabilities and costs etc.

A strategic alliance is similar to a JV, but no separate entity is formed. Instead, it’s a collaboration between businesses and is often less structured and less permanent.

Crowdfunding: This allows a company to raise capital online through a large number of smaller investors.

If you'd like to find out more about alternative ways you can raise capital for your business, get in touch with us and talk to one of our specialists. We tailor all our solutions to your business needs.

 


BY Jessica Lambert

27 January, 2022

4MIN

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