IPOs are an important component of the stock market. Here are the basics of what they are and how they work.
- The first time a corporation offers its stock for sale to the public is called an Initial Public Offering, or IPO. Many companies are privately held and their stocks are not for sale to the public. But when a company wants to expand, it often finds it advantageous to offer stock on the primary market. This way, it can raise new capital or fund its future growth and operations.
Before it can issue new stock, a corporation must file registration statements with the Securities and Exchange Commission. The issuing company may make its registration statement public with a preliminary prospectus, called a red herring, that summarizes the registration statement. This includes how many shares are being offered and which brokerage companies will distribute the stock to the public.
A corporation going public hires an investment banker to help sell its stock. This process is called underwriting. The investment banker functions as an intermediary between the issuing corporation and the public. The SEC also requires the underwriter to investigate the issuing company, particularly any audits, how it uses proceeds, its financial statements, and the management team. This process is called due diligence.
The prospectus must be provided to customers before they complete any transactions. A new issue of stocks is allowed to be advertised before it is actually sold, although it may not be sold during the actual registration period. Stay financially fit, friends.