Investing Basics: What happens when a company goes public

Investing Basics:  What happens when a company goes public

Eileen St. Pierre, The Everyday Financial Planner

It’s been almost 16 months since Facebook went public.  Going public is called an initial public offering or IPO.  The Facebook IPO was the largest Internet IPO and one of the top 5 U.S. IPOs ever done.  Some people asked why Facebook went public when the economy was still soft.  According to U.S. regulations, once a company has 500 shareholders (owners), it is required to open up its books and go public.  So Facebook really didn’t have a choice.

The IPO Process

An IPO occurs in what we call the primary market, where the company raises capital (Facebook raised $16 billion – $9 billion more than they expected).  The company needs to hire a group of underwriters (investment bankers) to help price its shares of stock and line up investors.  These underwriters earn their money through commissions.  There is a lead underwriter (like Morgan Stanley for Facebook’s IPO) who will earn the largest commission on the stock sale.  The money paid for the shares (less commission) goes directly to the company.  Because it is a stock sale, the company is not required to repay this money back to investors.  In a bond sale, the money needs to be repaid.

Immediately after the IPO takes place, the company’s shares will start trading on an exchange in what we call the secondary market.  Each exchange has its own listing requirements and will assign a ticker symbol to the stock.  For example, Facebook shares trade on the New York Stock Exchange under the ticker symbol FB.  Shares of Apple trade on the NASDAQ under the ticker symbol AAPL.

Once the company’s shares start trading on the exchanges, the company receives no more money for these trades.  Money passes between buyers and sellers.

Pros and Cons of Going Public

Pros

  • Allows the founders of the company to “cash out”
  • Exposure, prestige and public image
  • Better access to more capital in the future
  • Stock is more liquid and marketable
  • Easier to retain managers and top employees through the use of stock options
  • More shareholders (owners) mean there are more people to share the risk of operating the company

Cons

  • Significant legal, accounting and marketing costs for the IPO
  • Ongoing financial disclosure requirements
  • Risk the required amount of capital will not be raised if the IPO stock price is set too low or demand for the shares is too weak
  • The now public information about the company may be useful to competitors, suppliers and customers

Very few small investors get to participate in IPOs.  Public offerings are usually sold to large, institutional investors like banks and pension funds and the retail clients of the underwriters.  But the minute the stock begins trading on an exchange, you get your chance to buy your very own piece of the company.

Visit my Basic Financial Management page for more information on investing.