What is an Initial Public Offering? - Definition & Process

Instructor: Usha Bhakuni

Usha has taught high school level Math and has master's degree in Finance

In this lesson, we will learn what an initial public offering is, why companies do it, who the major players involved in the process are, and how it takes place.

Initial Public Offering

Imagine that a company wants to expand its business to new geographies. What does it need in order to do that? Of course, it needs money (capital). There are various ways to raise capital. An initial public offering is one of the ways for a company to raise capital.

Initial public offering (IPO) denotes the first time that a previously private company offers its equity shares to the general public. The company's shares start trading on stock exchanges after this. IPOs are generally issued by companies in their growth stage to access more capital or by big private companies looking to get publicly traded or to get an exit route for the existing investors. Usually, the decision to issue an IPO is taken by the board of directors and major shareholders of the company.

So, are you excited to know how it all works? Let's understand the IPO process below.

IPO Process

Once the decision to go for an IPO is made, the process begins. This can be broken down into the following steps -

1. Hiring an Underwriter: An underwriter is the investment bank that will guide the company through its IPO process. Often, companies decide to go with more than one underwriter for the process. In such cases, the leading bank is known as the book runner and other banks become the co-managers. These underwriters typically charge a fee of 3-7% of the final offering size.

2. Due Diligence: The underwriters make the due-diligence review of the company's financial, competitive, and legal position. They review the historical financial statements, talk to industry experts, and review contracts and registrations. This is done to ensure that the registration documents are accurate. This process typically takes a few months to complete.

3. Filing the Registration Statement: At the end of the due diligence process, the company submits a registration statement to the regulatory body. For example, in the USA the companies submit a S-1 form to the Securities Exchange Commission (SEC). This document reveals crucial information, such as historical financials, how many shares are to be sold, risk factors, current ownership of the company, etc. These documents can be seen by the public as well. The regulatory body checks the documents to determine if the company has provided enough information for potential investors.

4. Preparing Preliminary Prospectus: Once the registration documents are submitted, the company and the underwriters decide how to sell the shares to investors. The underwriters prepare a red herring prospectus, which gives out all the necessary information to the investors in a concise form. This prospectus has a warning on the first page that says it is not the final prospectus. It usually does not have the offering price, commissions, or discount information.

5. Pre-selling the Offering: Now the underwriters approach potential institutional investors with the red herring prospectus to explain to them about the company's offering. They ask the investors what price they would pay for the offering. Based on this feedback, they determine the price range of the offering. This usually takes a couple of weeks. After this, the price band is added to the regulatory documents filed earlier.

6. Going on the Roadshow: This is where the real marketing of the offering happens. The management of the company travels to gauge interest in their offering. They meet with investors, make live presentations, and answer queries. In this stage, the company takes orders from the investors, and then revise the price range based on investor feedback. Essentially, the roadshow acts as a final price discovery for the offering. It might also lead to an increase or decrease in the number of shares offered. The roadshow typically goes on for one-two weeks.

To unlock this lesson you must be a Study.com Member.
Create your account

Register to view this lesson

Are you a student or a teacher?

Unlock Your Education

See for yourself why 30 million people use Study.com

Become a Study.com member and start learning now.
Become a Member  Back
What teachers are saying about Study.com
Try it risk-free for 30 days

Earning College Credit

Did you know… We have over 200 college courses that prepare you to earn credit by exam that is accepted by over 1,500 colleges and universities. You can test out of the first two years of college and save thousands off your degree. Anyone can earn credit-by-exam regardless of age or education level.

To learn more, visit our Earning Credit Page

Transferring credit to the school of your choice

Not sure what college you want to attend yet? Study.com has thousands of articles about every imaginable degree, area of study and career path that can help you find the school that's right for you.

Create an account to start this course today
Try it risk-free for 30 days!
Create an account