An IPO, or initial public offering, occurs when the board of directors of a privately owned company makes the decision to issue shares in the company that can be sold to the public. As a way for a company to bring cash into the business, the IPO process is long, complicated and expensive. However, based upon the company’s objectives, an IPO could be the best way to prepare for the business’ future.
The IPO Process
Taking a company public requires planning. The board of directors must meet and vote on the proposal. The company's financial statements must be audited. IPO specialists, such as advisers and consultants, must be interviewed and hired. The company must find an underwriter, the investment banker who will have the right business contacts to get the shares to the investors and the experience to create excitement about the offering. The underwriter also establishes the starting price for the stock and creates the prospectus, which is reviewed by the Securities and Exchange Commission (SEC) to confirm that it meets the proper regulations. After the prospectus is approved, the corporate executives visit major cities to meet with potential investors to try to create interest in the upcoming IPO.
Upgrading and Expanding
Raising money to buy equipment and/or expand a business is typically the primary objective of an IPO. The company might need to buy equipment for several reasons, such as the desire for more efficient processing, business growth that requires higher production capacity or simply replacing equipment that is old and obsolete. Even companies that are not manufacturers could require additional funds to expand, such as needing additional office space, office equipment and staff. Having publicly traded stock is also used as a tool to attract business talent by being able to offer incentive stock options.
Sometimes it makes sense to take a company public if the objective is to pay off a large bank loan. The interest paid on that loan cuts into company profits. With the funds raised from an IPO, the bank loan can be repaid and, without the loan interest expense, the company can show more profit on its income statement.
When a company is started and is privately held, shares in it are issued to the founders and any people who choose, such as investors who provided funding, management or company employees. Because the shares are not traded publicly, they have very little value. By taking the company public, the value of the shares can significantly increase. Anyone who received the shares when the company was privately held can sell them on the open market, possibly for a large profit.
At some point, the founder of a business will decide he no longer wants to be involved in the day-to-day operations. Whether the reason has to do with age, illness or just wanting to move on and start another company, an IPO can make it easier to sell shares by increasing the value of the company and having the shares traded on the open market.
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