Definition: An IPO is short for an initial public offering. Like the name says, it's when a company initially offers shares of stocks to the public. This is also known as going public. An IPO is the first time the owners of the company give up part of that ownership to stockholders.
Advantages of an IPO for the Company
The IPO is an exciting time for a company because it means it has become successful enough to require much more capital to continue to grow. It's often the only way for the company to get enough cash to fund a huge expansion. For the owners, it's finally time to cash in on all their hard work. They usually award themselves a large percentage of the stock, and so stand to make millions the day it goes public.
The IPO may also allow the company to attract top talent because they can offer stock options. They can pay these early executives little or no wages with the promise they can cash out with the IPO.
Disadvantages of an IPO to the Company
Unfortunately, the IPO process requires a great deal of work. This can distract the company leaders from their business, which can hurt profits. They also must hire an investment bank, such as Goldman Sachs or Morgan Stanley, to help them go through the complexities of the process. This is very expensive.
Second, the business owners may not be able to take many shares for themselves. Instead, their original investors might require them to put all the money back into the business. Furthermore, even if they take the shares, they make not be able to sell them for years. They may even be actually prohibited from selling the stock. Even if this isn't the case, they could hurt the stock price if they start selling large blocks, because it could be seen as a lack of confidence on their parts. Third, they could lose ownership control of their business. (Source: Susan Ward, About.com Guide to Small Business Canada, IPO)
Fourth, a public company faces much more intense scrutiny and regulations from the SEC, the Sarbanes-Oxley Act and shareholders. Many details about the company's business, and its owners, will now become public. This could give valuable information to competitors. (Source: Inc, How to Prepare for IPO, February 1, 2010)
Advantages of an IPO to InvestorsThe IPO is also an exciting time because the initial shares of stock are usually only available to those who know about it. Many investors prefer to get in "on the ground floor." That's because IPO shares can often skyrocket in value when they are first sold on the stock market.
Disadvantages of an IPO to InvestorsHowever, there is usually a clause that restricts IPO investors from selling for the first 30 days. Sometimes an IPO's value skyrockets, only to plummet to earth a few days later.
What IPOs Mean to the EconomyThe number of IPOs being issued is usually a sign of the stock market's, and economy's, health. During a recession, IPOs drop because it's not worth the hassle if stock prices are depressed. When IPOs increase, it usually means the economy is getting back on its feet again.
What Is the IPO Process?
The IPO will take about a year, and cost more than $2 million in fees and other expenses. Most companies designate a staff person to be the project manager. The next step is to put together the IPO team, consisting of the investment banker, lawyers, accountant and SEC expert.
Once the team has been put together, the next step is to start putting together the financial information required. This includes identifying, selling or writing off unprofitable assets, and finding areas where cash flow can be beefed up. Some companies also look for new management and a new board of directors to run the new public company.
Around 8-10 months before the IPO is scheduled, companies put together the prospectus and circulate it for comments. The prospectus includes a three-year history of financial statements.
Six months out, transition contracts for vendors must be written. Next, financial statements are completed and submitted for auditing.
Three months before the IPO, the board meets and reviews the audit. The company joins the stock exchange it will issue the IPO with. In the last month, the company files its prospectus with the SEC, issues the press release and sells the stock.
In addition to the upfront fees, companies pay around $500,000 a year in accounting and insurance fees just for being a public company. For more detailed information, see these sources: Matt H. Evans, CPA,CMA,CFM Creating Value through Excellence in Financial Management, The IPO Process; Inc, How to Prepare for IPO, February 1, 2010. Article updated September 12 ,2013