How does an IPO Work | Complete Guide

How does an IPO work? An IPO happens when a public company begins trading on a public market. IPO means initial public offering. On the day of an initial public offering the public has an opportunity to buy stock in a company for the first time.

What is an IPO Timeline and How does an IPO Work

IPO work begins months if not years before the stock trades on an exchange. Companies decide to go public for several reasons. Some of the most common reasons are that they need to raise more cash than they can get from the private market or that private investors want liquidity.

The planning for a public offering begins with a company board. The board decides for whatever reason, that they want to make the company public. Usually, at this point the company cleans up its financial statements (more on this later). The company attempts to make the balance sheet, P&L, and cash flow statements look as good as possible. They want to make the company look as good as possible for much the same reason you clean your house before company comes over.

The company reduces spending on research and development or advertising to make the company look more profitable. On the other hand it may be by increase advertising expenses to make revenue growth expand. They’re several things that they look at to try to get the best value for the company.

The company hires one or more banks to broker the IPO and they in turn banks advise on pricing, share counts and the best way to manage the deal. Next we will discuss how does an IPO roadshow work?

Filing and Roadshow

One of the main things to know about How does an IPO work is when the company prepares to go public they begin by filing a form S1 with the Securities and Exchange Commission (SEC). The S1 is a registered sales document. The company uses this document as a guide to sell the stock to the investors that will participate in the IPO. The construction of an S1 includes; financial statements, risks, and forward looking statements intended to give a vision for the company.

The first time an S1 gets filed it tends to be incomplete. The company files an S1 that does not have certain information such as; the number of shares, price of the shares, and the total amount of money they want to raise. They do this to test the waters and get some feedback on the best ways to structure the deal to maximize value for the company and investors. Before moving on to the next step the company will file an S1/A which is an S1 amended.

The next step is the road show, when the company goes and visits with investors. They give a presentation covering all the information in the S1 and answering questions. The vast majority of the shares that will be given will go to the brokers and investors that are on the road show.

The day before the IPO the company announces the final IPO price. This is the price you will pay for shares at the IPO if you can get them.

IPO Day

The final phase of how does an IPO work. The day of the IPO shares are allocated before the market opens. If you do not have shares at this point you will have to buy them on the open market like everyone else. When the market opens the stock does not start trading. Representatives of the exchange work to match orders and find the price for the stock to open.

The goal of the exchange is to make the opening of the stock as smooth as possible. They try to match a certain amount of buy orders from the public and sell orders from those that received shares in the IPO. The exchange representatives do not want the stock to jump around at the open and scare investors so they typically take 2 or 3 hours to find the right price to open the stock.

While the exchange is working on the opening they give indications or price ranges where they think the stock will open. The indication range narrows over time until they find the right price for the market. When the right price is found the market opens and the stock begins trading publicly just like any other stock. Now you know how does an IPO work.

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