The world of investment often seems far removed from the average citizen. The jargon, suits and ties, and the abundance of acronyms in the investment industry can often feel separate from the everyday person who in these days, is hard pressed to know how to write a check. Over the course of this three-part series on investment, beginning with a look into the basics of stocks, moving into a discussion on the exponential growth of the latest investment model, and concluding with a look into a unique investment vehicle run entirely by a female management team, we will return the power of the investment industry back into the hands from which it was derived – from the citizen.
Q: What is an Initial Public Offering (IPO)?
A: Let’s say we have a company, Green, that is privately owned and sells products made entirely from sustainable materials like recycled water bottles and old gym sneakers. Now, Green wishes to go from being a privately held company to a publicly held one. This transition means that Green will need to “go public” which will require the company to acquire an IPO, an initial public offering. With an IPO, Green would be able to list its shares on a stock exchange, making them available for purchase by the general public.
Q: What happens when Green lists its shares on a stock exchange?
A: That Green would now be offering units of ownership, or common stock, in their company to the public. If the public purchased common stock in Green, they would be called shareholders who now have the ability to vote on company matters and receive company dividends. Dividends are how a company distributes their earnings to their shareholders, and the dividend you receive is based off of the amount of shares in the company that you own. For example, if you owned one share in Green, the dividend you receive could be $20 in cash as a representation of Green’s earnings.
Q: Why would Green go public?
A: For four reasons:
Green can raise capital (ex: cash) by selling shares to the public. This capital can then be used to fund different innovation projects Green is working on, offset the cost Green’s business operations as a whole, or pay off some of Green’s debts.
By going public, Green can go through a less expensive route to raise capital rather than working with pricey private investors and bank loans.
With an IPO, Green now gains publicity in the market which means more people know about the company which could increase Green’s revenue.
Having an IPO gives Green a different, public standing than it had as a privately held company. With an IPO, Green can settle on better terms with future investors and lenders who want to support the business.
Q: How does a company, like Green, acquire an IPO?
A: The company needs to prepare for public scrutiny, as well as organize all of the paperwork and financial disclosures in order to meet the requirements of the Securities and Exchange Commission (SEC) which oversees public companies. Because the process to acquire an IPO requires intensive collection of business records, Green will most likely hire an underwriter, usually an investment bank, that will help to gather financial records, as well as schedule meetings with potential investors, called roadshows. The underwriter will also help set the initial price for the IPO offering, also known as an issue price or offering price. The issue price is the price at which shares of common stock are sold to investors before a company begins trading on public exchanges. For example, the underwriter that Green hires may set the issue price at $15. Once the issue price is set for the IPO, the underwriter issues shares to investors and Green’s stock begins trading on a public stock exchange such as the New York Stock Exchange (NYSE) or Nasdaq.
Q: Why are issue prices important?
A: The idea of the issue price comes into play when you, the average citizen, decide that you want to buy IPO stock. The way that you can buy IPO stock is through a stock broker such as TD Ameritrade or Fidelity. You will also need to meet certain eligibility requirements to purchase IPO stock and even then, you probably will not be able to purchase shares in a company at the initial issue price. This means that by the time Green acquires an IPO and is able to sell shares to the public, you may end up purchasing stock in Green at $30 rather than the initial issue price of $15.
Q: What changes for a company, like Green, once it goes public?
A: Once Green goes public, the company will be required to submit quarterly and financial reports to satisfy disclosure requirements set out by the SEC. Also, Green will now need to answer to shareholders by maintaining reporting requirements that alert shareholders to changes in Green such as Green’s selling of assets or acquisition of another company. So, while acquiring an IPO comes with its own set of pros, such as increased capital and consumer recognition, these companies have to meet a considerable amount of regulations and keep up with the pressure of maintaining their public image.
However, a company’s avenue towards going public does not need to follow the route ending in an IPO. Enter SPAC, a special purpose acquisition company.
Stay tuned for my next article detailing the history and life cycle of SPACs and how this new investment form is paving a new path for private businesses looking to go public.