Initial Public Offering (IPO)

An initial public offering (IPO) is the first time a private company sells its shares to the general public. The company, usually helped by investment banks acting as underwriters, registers the offering with the securities regulator, sets a price, sells new shares (and sometimes existing ones) to investors, and lists the shares on a stock exchange where they then trade freely. The IPO turns a privately held business into a public company with reporting duties.

IPOs are the main route from venture capital and private equity ownership to the public capital market. They are often compared with direct listings, where no new money is raised, and with crypto token sales such as the initial coin offering (ICO) and initial exchange offering (IEO), which borrowed the IPO name without its disclosure rules. In the United States, IPOs are overseen by the Securities and Exchange Commission (SEC).

Think of a family bakery that has grown into a chain. Until now, the family and a few backers own it. To raise money for new shops, they invite the public to buy a slice of the business, and hire a firm that knows how to find buyers and set a fair price.

Before anyone can buy, the bakery must publish a thick booklet explaining its finances, risks and plans, checked by lawyers and accountants. Once the slices are sold, they can be resold to anyone on a public marketplace, and the bakery has to keep publishing updates for as long as it stays public.

1. Preparation. The company chooses lead underwriters, gets its accounts audited and tidies its cap table; preferred shares and instruments such as a simple agreement for future equity (SAFE) are usually converted into common stock at listing.
2. Registration. Under the Securities Act of 1933, the company files a registration statement, usually Form S-1, containing the prospectus: audited financials, risk factors, use of proceeds and management details. SEC staff review it and send comments before it can be declared effective.
3. Marketing. Management and underwriters hold a roadshow with institutional investors and build a book of orders at a price range, a process known as book-building.
4. Pricing and allocation. The night before trading, the company and underwriters set the final price and allocate shares. In a firm-commitment deal the underwriters buy the shares and resell them, taking the risk described under underwriting.
5. Listing. Shares open on an exchange under a ticker symbol. Insiders are typically bound by lock-up agreements, commonly 180 days, before they can sell.

The underwriters' fee is the gross spread. The company's net proceeds are:

• $N$ is the net amount the company receives.
• $Q$ is the number of new shares sold.
• $P$ is the offer price per share.
• $g$ is the gross spread, as a decimal.

Worked example: selling 10 million shares at $20 with a 7% spread gives $10{,}000{,}000 \times 20 \times 0.93 = 186$ million dollars, before legal, audit and listing costs.

IPO prices are set by negotiation, not by open bidding, and many IPOs rise sharply on the first day. The "pop" benefits investors who received allocations but means the company raised less than it might have; researchers call this underpricing. Alternatives have tried to improve price discovery. Google's 2004 IPO used a modified Dutch auction, selling about 19.6 million shares at $85 to raise around $1.67 billion.

A direct listing skips the underwritten sale: existing shareholders simply begin selling on the exchange, and the opening price is set by an auction of buy and sell orders. Coinbase, the U.S. crypto exchange, went public this way on Nasdaq on 14 April 2021. It is often described as a crypto IPO, but it was a direct listing, not an IPO: Coinbase sold no new shares, and Nasdaq published a reference price of $250 only as a guide for the opening auction. Spotify had made the first high-profile direct listing on the New York Stock Exchange in 2018.

A public company must file regular reports with the SEC, follow exchange governance rules and observe insider-trading restrictions; see insider trading. Its shares may enter a stock market index, attracting index funds and exchange-traded funds (ETFs). Retail investors usually buy through a broker once trading opens.

IPOs are expensive and slow, and critics argue that allocation favours large institutional clients of the underwriters. Lock-up expiries can also push prices down, a pattern crypto traders recognise from each token unlock. Token sales copied the IPO's language but, in their early form, skipped the prospectus, audit and registration steps, which is why the SEC applied the Howey Test to many of them. The regulated crypto equivalent is closer to a security token offering (STO). Further background on exchanges themselves is under financial exchange.

• U.S. Securities and Exchange Commission: Going public
• Google Inc. Form S-1 registration statement (2004)