An initial public offering (IPO) is the process by which a company’s shares are first made available to the public through a stock exchange. This step is often a significant milestone in the life of a company, as it enables it to raise capital for further growth and development. In this article, you will learn how IPOs work, what benefits and risks they bring to companies and investors, and why this process is an important part of the financial market.
What is an Initial Public Offering (IPO)?
Initial Public Offering (IPO) is the process by which a company offers its shares to the public for the first time for trading through a stock exchange. This step transforms the company from private to publicly traded, allowing a wide range of investors to own a stake in the company. The IPO is a significant milestone for the company, as it not only brings access to new capital, but also significant changes to its organizational and regulatory structure. This process is often associated with fast-growing companies that need financing for further expansion, but IPOs can also be beneficial for established companies seeking new sources of financing.
Why do companies choose to IPO?
The decision to go public through an IPO is a strategic move that affects the company’s future on multiple levels. This process brings several benefits and opens up new opportunities, but it also comes with certain challenges and responsibilities. The main reasons why companies opt for an IPO are, for example:
Raising capital for growth and expansion: an IPO is one of the most effective ways for a company to raise a significant amount of capital. This capital is typically used to expand production capacity or operations in new markets, finance research and development (R&D) for new products or technologies, acquire or merge with other companies, and reduce debt burdens.
Increased visibility and prestige: a publicly traded company gains a higher level of trust and recognition from the public, partners and customers.
Liquidity for existing shareholders: an IPO allows founders, investors and employees to obtain liquidity from the sale of their shares. For early investors, such as venture capital firms, an IPO is an important step to monetize their investment.
Diversification of ownership: when a company goes public, it spreads ownership among public shareholders. This can reduce dependence on the original owners and mitigate the risks of capital concentration, providing the company with greater stability through a broader range of investors.
Access to additional capital in the future: an IPO opens the door to other forms of financing such as Secondary Offerings. Public companies have easier access to capital markets and can raise additional funding more efficiently.
Employee incentives: publicly traded companies may offer stock options or shares as part of a compensation package. This approach motivates employees to perform better because their rewards are directly linked to the company’s success. This helps attract and retain talented professionals.
Business transformation and process improvement: preparing for an IPO often involves complex financial audits, restructuring and implementation of processes that make the company more efficient and transparent. Going public also forces a company to adhere to stricter standards, which can improve governance and decision-making processes.
Realising the company’s potential: a public offering of shares allows a company to achieve a market capitalisation that reflects its current and future potential. This can significantly increase the value of the company, making it attractive to both investors and employees with shares.
The IPO process: how does a company go public?
An IPO is a complex process involving legal, financial and organisational steps. The aim of an IPO is to enable a company to sell its shares to the public and become publicly traded. The process is regulated and requires cooperation with investment banks, lawyers, auditors and regulators.
Preparing the company for IPO
Before the IPO is actually launched, the company must assess its readiness to go public. At this stage, the following steps are usually implemented:
Change of structure to a public limited company (plc): the company must have a legal form that allows public trading of shares.
Financial audit: the company must demonstrate the credibility of its financial statements and sound management.
Optimising processes and internal systems: an IPO requires transparency and the ability to comply with strict regulatory requirements.
Setting up the IPO team: the team includes lawyers, financial experts and investment bankers who manage the whole process.
Underwriter selection (underwriter)
The company hires an investment bank or syndicate of investment banks to act as intermediaries between the company and the investors. The role of the underwriter is to:
Determining the value of the company: by analysing the market, assets and expected demand, the value of the company and the issue price of the shares are estimated.
Preparation of the issuance plan: design of the strategies for the launch of the shares, including the size of the issue and the allocation of shares between institutional and retail investors.
Risk consultancy: assessment of market risks associated with IPOs and suggestions for minimising them.
Drawing up a “prospectus”
The prospectus is a key document that a company publishes before an IPO. It contains:
Basic information about the company: history, business model, management and future strategy.
Financial statements: including audited financial statements for previous years, which provide a picture of the company’s financial health.
Risks: identification of the risks associated with investing in company shares.
Use of capital raised: how the company plans to use the funds raised from the IPO.
This document must be approved by the relevant regulatory authority, such as the Securities and Exchange Commission (SEC in the US, NBS in Slovakia) or other authority depending on the jurisdiction.
Roadshow and IPO marketing
Prior to the official launch of the IPO, the company meets with potential investors in an IPO roadshow. The aim:
Present the company: provide investors with a detailed view of its business activities, strategy and market opportunities.
Build interest: persuade institutional investors such as funds and banks to invest in the company’s stock.
Demand testing: the underwriter estimates the demand for shares based on investor feedback and adjusts the issue price or issue size.
Determination of the issue price of shares
Based on the results of the roadshow and market analysis, it will be determined:
Initial issue price: the price at which the shares will be offered to investors. This price must be attractive to investors but at the same time reflect the value of the company.
Number of shares: the decision on the number of shares to be issued and their distribution between institutional and retail investors.
Primary subscription of shares
Primary market: shares are offered to initial investors such as investment funds, banks and large players.
Secondary market: after the initial subscription, the shares start trading on the stock exchange, allowing the general public to buy and sell them.
First trading on the stock exchange
On the day of the IPO, the shares will start trading on the stock exchange. This day is an important milestone because:
Determine the market price of the stock: the first trade will determine the fair market value of the stock based on supply and demand.
Liquidity: investors can buy or sell shares freely.
Visibility: listing on the stock exchange increases a company’s publicity and prestige.
Life after IPO
After the IPO, the company becomes publicly traded, which brings with it new obligations:
Regular financial reporting: the company must regularly publish its results and comply with accounting standards.
Protection of shareholders’ interests: corporate governance is guided by the principles of transparency and accountability to public investors.
Dealing with stock volatility: stock prices can be subject to market fluctuations, which requires effective communication with investors.
The IPO process is challenging and complex, but it is also a strategic opportunity for a company to raise capital, increase its prestige and support growth. A successful IPO depends on careful preparation, collaboration with experts and the right timing given market conditions.
Advantages of an IPO
Listing a company on the stock exchange through an IPO brings many benefits that can promote growth, strengthen financial stability and increase the prestige of the company. Key benefits of an IPO:
Raising capital for growth
An IPO allows a company to raise substantial funds for business development. This capital can be used for:
Expansion into new geographic regions.
Increase in production capacity.
Research and development of new products and technologies.
Repayment of existing debts.
Increased visibility and reputation
Becoming a publicly traded company increases trust and brand recognition among customers, business partners and investors. This status can promote:
Better access to business opportunities.
Strengthening customer trust.
Increased prestige in the market.
Liquidity for existing shareholders
An IPO allows founders, early investors and employees who own shares to sell their shares and raise funds. This is particularly important for venture capital funds and other investors looking for an exit from their investment.
Access to additional capital
After a successful IPO, the company has easier access to additional forms of financing, such as:
Secondary public offerings of shares.
Bond issues.
Motivation for employees
An IPO allows a company to introduce stock options as a form of remuneration, which can:
Improve employee loyalty and performance.
To help attract and retain top professionals.
Diversification of ownership
Public trading spreads ownership among a large number of shareholders, reducing dependence on a few founders or investors. This can bring greater stability and flexibility to a company.
Increased company value
A publicly traded company often has a higher market value as a result of better share liquidity, greater transparency and investor confidence. Higher market capitalisation can be useful, for example, in acquisitions.
Access to international markets
IPOs on global stock exchanges allow companies to raise capital from foreign investors, opening up opportunities for expansion and international cooperation.
Improving financial and organisational discipline
Preparing for an IPO and then having to disclose financial results and comply with regulatory standards often leads to improvement:
Financial processes and management.
Transparency and credibility of the company.
How to invest in an IPO?
Investing in an IPO can be an attractive opportunity for capital appreciation, but it requires careful preparation and understanding of the process. The first step is to identify an IPO that interests you through stock exchange announcements, financial news or intermediaries. Once you have selected an IPO, review the company’s prospectus, which contains key information about its financial health, business model, risks and plans for using the capital raised. Next, you need to open an investment account with a broker that allows access to the IPO. Some brokers offer direct access to IPOs for retail investors, but they are often allocated to institutional investors on a priority basis. During the underwriting process, you may express an interest in a certain number of shares, but the amount allocated may depend on demand and broker policy.
Examples of successful IPOs in Slovakia and around the world
Throughout the history of financial markets, there have been many successful IPOs that have impacted the global economy.
The largest and most successful IPOs in the world
Saudi Aramco (2019):
IPO proceeds: $29.4 billion
Saudi oil company Saudi Aramco conducted the largest IPO in its history when it floated on the Tadawul exchange in Riyadh in December 2019. The move raised $29.4 billion, breaking previous records.
Alibaba Group (2014):
Amount raised in IPO: USD 25 billion
Chinese e-commerce company Alibaba went public on the New York Stock Exchange (NYSE) in September 2014, raising US$25 billion. This debut was the largest IPO in the world at the time and significantly strengthened the company’s global presence.
SoftBank Corp (2018):
IPO proceeds: $23.5 billion
Japanese telecommunications company SoftBank conducted one of the largest IPOs in December 2018 when it listed on the Tokyo Stock Exchange and raised US$23.5 billion.
Agricultural Bank of China (2010):
IPO proceeds: $22.1 billion
One of China’s largest banks went public on the Shanghai and Hong Kong stock exchanges in 2010, raising US$22.1 billion.
Industrial and Commercial Bank of China (2006):
IPO proceeds: $21.9 billion
This Chinese bank had one of the largest IPOs in 2006 when it listed on the Shanghai and Hong Kong stock exchanges, raising USD 21.9 billion.
Risks associated with an IPO
Initial Public Offering (IPO) brings great opportunities for companies, but also significant risks that can affect not only the IPO process itself, but also the future of the company after going public. The main risks associated with an IPO include:
High cost of the IPO process: legal and regulatory requirements, financial audit and advisory services require significant investment. Investment banks charge commissions for their services, which can amount to 5-7% of the IPO proceeds. Roadshow and IPO promotion can be costly.
Risk of share mispricing: if shares are undervalued, the company raises less capital than it could. If shares are overvalued, their value may fall after trading starts, damaging the company’s reputation.
Pressure for short-term results: publicly traded companies face investor and market expectations. Management may be forced to focus on short-term results instead of long-term goals to satisfy shareholders.
Increased regulatory obligations: publicly traded companies must comply with strict rules, including regular disclosure of financial statements, activity reports and other regulatory requirements. Failure to comply with regulatory requirements can lead to penalties, reputational losses and legal problems.
Loss of control of the company: extending ownership to public shareholders means that founders and original investors may lose decisive influence. Large shareholders, such as investment funds, may push for changes in management or strategies.
Share price volatility risk: after a stock exchange listing, the share price may be affected by factors such as market conditions, economic conditions, company news and speculation. Significant falls in share prices can negatively affect a company’s reputation and investor confidence.
Public scrutiny and reputational risk: the public and the media have greater access to information about the company, which can lead to increased scrutiny and criticism. Negative events, such as legal disputes or disappointing results, can damage the company’s image.
Risk of IPO failure: if there is insufficient investor interest in the shares, the IPO may fail, leading to financial losses and damage to the company’s reputation.
