Public Equity Funds: Definition & Structure

Instructor: Sara Huter
Public equity funds are a source of financing generated from selling a company to the public. When this is done, it is called an initial public offering, or IPO. This lesson describes how to structure an IPO.

Public Equity Financing

What happens when your successful company cannot grow because you don't have the money to invest in it? If you're lucky enough to have this problem, you want to make sure there's money to grow. One option is public equity. Let's learn more about public equity and how it is structured.

Imagine you are a founder of an online bookselling company. Your company is successful, but you know it could sell more than just books. You want your company to become the world's largest online store. In 1997, this is what occurred when Jeff Bezos, founder of Amazon.com, took the company public. With public equity funds, Amazon.com not only became the largest online retailer, but one of the largest retailers. Public equity financing made this possible.

Jeff Bezos founded and oversaw the IPO for Amazon.com and led the company to become the largest online retailer.
Jeff Bezos

What is public equity financing? You may have heard the term initial public offering (IPO). This is when a company offers shares of its company to the public. For each share sold, an individual, or a shareholder owns a small piece, or share of that company. The shareholder hopes to someday sell that share to someone else for a profit. When the public owns the company, the company must act in the interest of its many owners, or shareholders. In essence, the owner gives up control of the company.

So how does a company go about getting public equity funds? Becoming a public company requires a company to go through the ULTA process: It must hire an Underwriter, decide where to List its shares, determine the Type of stock to offer, and, finally, Act like a public company.

Hiring an Underwriter

First, the company hires an underwriter to structure the initial public offering. An underwriter is the middleman that buys the initial shares from the company, approaches investors, and determines the initial price to sell to investors. They keep a portion of the proceeds as the fee. Large IPOs may have several underwriters, typically investment banks. Investment banks are financial intermediaries that specialize in complicated financial transactions, such as IPOs.

Where to List

With its investment bank, a company decides how to structure its public equity funds. An important question is, where shall we sell the funds? There are many public markets worldwide. In the United States, the two largest markets are the New York Stock Exchange (NYSE) and the NASDAQ. Where you sell shares depends on which investors would respond favorably to a company's stock.

Once a upon a time, the NYSE was known for only listing large companies, such as IBM, Ford, or Microsoft, while NASDAQ attracted tech startups. Today, the line has blurred, although the NYSE is still pickier when choosing companies to list. NASDAQ attracts smaller companies with more risky ventures. The NYSE dates back to 1792, and therefore, still uses an auction-type of trading floor, although it has become largely computerized. NASDAQ started out in in 1971 as a computerized trading model.

Types of Stock

The next question a company asks is, shall we offer common shares, preferred shares, or both? Common shares are simply shares of the company. They offer shareholders a right to vote at the annual shareholder meeting, and the share price can vary widely. The company may choose to pay dividends to common shareholders. Dividends are payouts, usually a portion of the profits. Preferred shares have some strings tied.

If you own preferred shares of a company, chances are that you get a guaranteed dividend every quarter. That is, the company is required to pay you a certain amount of its profits for every share you own. In fact, even if the company is not profitable, it may still be required to pay you a certain amount.

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