Initial public offering (IPO)

Quick definition

An initial public offering (IPO) is when a private company lists ‘goes public’ by listing its shares on a stock exchange to raise capital.

Key details

• An IPO offers a way for companies to raise money by selling shares to the public
• IPOs are typically underwritten by investment banks, who decide on an opening price and sell the shares to investors
• IPOs require significant disclosures from the company involved, in terms of financial statements

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.

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.

IPOs vs. FPOs Table