What is an IPO?

In 2012, Mark Zuckerberg opened his private company to the public. In the company’s initial public offering (IPO), $16 billion of stock were bought as investors sought to value the technology giant, vying for a share of its profits. Along with the selling of stock, Facebook’s management underwent a deep restructuring process.

Most people recognize an IPO as a company’s first introduction to the stock market, but what exactly is it? Most simply by Investopedia, an initial public offering is “the first sale of stock by a company to the public.” Before an IPO, equity is distributed among private investors whether it be the owner, individual angel investors, or venture capital funds. A company who initiates an IPO wishes to raise capital through the stock market which is accessible by investors across the world. Companies are usually private when they are first created, but through an IPO, they go public.IPO graphic

In exchange for the access to the public’s capital, the company must release their financial statements making the data visible to the public that is looking to invest. The Securities and Exchange Commission (SEC) require annual audited financial statements, interim unaudited financial statements, acquired company financial information, and other selected documents to be made transparent for an IPO according to Latham and Watkins. These include quarterly updates of a company’s financial condition filed with the SEC and, often, posted on the company’s website.

IPOs usually begin with the firm hiring an investment bank to manage the sales of its shares. The bank puts a team together to analyze financials, risk, and estimated funding before going forward with the process. The bank and the firm agree to an underwriting deal which sets what kind of securities will be offered. After this process, the bank helps the firm release its first public financial statements which are reviewed by the SEC before approving the IPO. This process is described at here at CNBC.

For entrepreneurs, the decision to go public can be one of the most important he or she makes for the company. The most obvious benefit to going public is the capital that is made available to you through the sale of stock, but this comes at the cost of equity in the company. With the sale of equity, the entrepreneur often has his or her own stake diluted. In addition to this, the new investors now have a claim on some of the company’s profits which are distributed in dividends.

Now that equity is divided among more individuals, the company’s management will change as well. Most notably, the entrepreneur must answer to a board of shareholders who have bought into the company and want to help run the company themselves. Often times, the addition of shareholders can provide access to more resources and knowledge, but sometimes, they can distract from the ultimate vision the original entrepreneur might have.

Companies that go public are also faced with the task of presenting sensitive information as required by the SEC. In the financial statements, companies must record the salaries of the leadership and the transactions of their equity. While transparency is not detrimental to the company, the amount of regulation (and time and money spent on managing the regulation) can sometimes get messy. Although, with the information and shares public, the company is able to claim a valuation rooted in the share price determined by investors.