Definition of ‘IPO’
The initial public offering (IPO) or the launch of a stock market is a type of public offering in which the shares of a company are sold to institutional investors and usually also to retail (individual) investors. One or more investment banks underwrite an IPO, which also arranges for the shares to be listed at one or more stock exchanges. Through this process, known colloquially as floating or going public, a privately held company is turned into a public entity.
IPO can be used to raise new equity funds for businesses, to monetize private sector interests such as business owners or private equity holders, and to make it easier to sell current shares or to raise additional money by becoming publicly traded.
After the IPO, shares are freely traded on the open market of what is known as the free float. Stock exchanges provide for a minimum free float both in absolute terms (the total value as calculated by the share price multiplied by the number of shares sold to the public) and as a proportion of the total share capital (i.e. the number of shares sold to the public divided by the total outstanding shares). While IPO provides many advantages, there are also significant costs involved, particularly those associated with the process, such as banking and legal fees, and the continuing obligation to reveal essential and sometimes sensitive information.
Advantage of IPO
An IPO accords several benefits to the previously private company:
- Enlarging and diversifying equity base.
- Enabling cheaper access to capital.
- Increasing exposure, prestige, and public image.
- Attracting and retaining better management and employees through liquid equity participation.
- Facilitating acquisitions (potentially in return for shares of stock).
- Creating multiple financing opportunities: equity, convertible debt, cheaper bank loans, etc.
Disadvantage of IPO
There are several disadvantages to completing an initial public offering:
- Significant legal, accounting, and marketing costs, many of which are ongoing.
- The requirement to disclose financial and business information.
- Meaningful time, effort and attention required of management.
- The risk that required funding will not be raised.
- Public dissemination of information which may be useful to competitors, suppliers, and customers.
- Loss of control and stronger agency problems due to new shareholders.
- Increased risk of litigation, including private securities class actions and shareholder derivative actions.