The Basics of an IPO

The Basics of an IPO

An initial public offering (IPO) is when a private company lists shares on a stock exchange and goes public to raise capital and enhance liquidity.
Updated: Jan 24, 2022
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Companies have various options at their disposal that they can use to raise capital. Initial public offerings (IPOs) and follow-on public offerings (FPOs) are some of the options that they use to meet their monetary needs.

IPOs and FPOs differ a great deal in the way they are carried out and how they’re priced, even though both of them serve the same basic purpose.

I. What Is an IPO?

An initial public offering refers to the listing of a private company in a stock exchange. The listing provides a way for a private entity to go public, and in the process raising capital by issuing equity in the company to retail and institutional investors. IPOs act as a turning point for many businesses as they are an effective way of raising money from the public to finance various projects.

The first step to an IPO involves a private entity selecting an investment bank that provides advice as well as underwriting service to the entire process. Once an IPO is approved by a regulatory board, the issuing company and the underwriter must agree on the appropriate date and the price at which the shares will go on sale.

How IPOs are priced

The IPO price is the price at which a company would be able to raise capital, depending on the number of shares bought by investors. Factors taken into consideration when determining the IPO price include the condition of the economy, the company’s goals, and its fundamental strength.

It is common for underwriters to underprice IPOs. The IPO price thus becomes enticing to investors, arousing confidence that the share price will rise significantly immediately after the IPO.

II. What Is an FPO?

Unlike an IPO, an FPO involves the issuance of shares of a company that is already listed on a stock exchange. It is essentially the issuance of additional shares after an IPO.

An FPO can be dilutive to current shareholders on a company’s board of directors who decide to increase the number of shares that will be in circulation. Companies opt to use this method to raise money to reduce debt or gain additional capital for business expansion.

The other option is a non-dilutive offering, which involves directors and current shareholders selling off privately held shares. In this case, there is no creation or issuance of additional shares. This is commonly referred to as a secondary offering.

How FPOs Are Priced

Pricing in an FPO is market-driven, as investors get a chance to evaluate a company before buying. Given that an FPO comes into play on companies already listed on an exchange, the price often comes at a discount to a stock’s closing market price.

While an IPO price is purely based on valuation, an FPO price often focuses on marketing efforts.

III. IPOs vs. FPOs Table

DefinitionIssuance of securities by a private entity to the publicIssuance of securities for subscription to the public by a publicly traded entity
Issuances StatusFirst public issueSecond or subsequent public issue
IssuerUnlisted companyListed company
ObjectiveRaising capital from the public for the first timePush for subsequent investment from the public
RiskHigh riskLow risk

Sources & references
Risk disclaimer
Harry Atkins
Financial Writer
Harry was a Financial Writer for Invezz, drawing on more than a decade writing, editing and managing high-profile content for blue chip companies, Harry’s considerable experience… read more.

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