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An initial public offering (IPO) or stock market launch is a type of public offering where shares of stock in a company are sold to the general public, on a securities exchange, for the first time. Through this process, a private company transforms into a public company. Initial public offerings are used by companies to raise expansion capital, to possibly monetize the investments of early private investors, and to become publicly traded enterprises. A company selling shares is never required to repay the capital to its public investors. After the IPO, when shares trade freely in the open market, money passes between public investors.
Details of the proposed offering are disclosed to potential purchasers in the form of a lengthy document known as a prospectus. Most companies undertaking an IPO do so with the assistance of an investment banking firm acting in the capacity of an underwriter. Underwriters provide a valuable service, which includes help with correctly assessing the value of shares (share price), and establishing a public market for shares (initial sale).
When a company lists its securities on a public exchange, the money paid by the investing public for the newly issued shares goes directly to the company (primary offering) as well as to any early private investors who opt to sell all or a portion of their holdings (secondary offering) as part of the larger IPO. An IPO, therefore, allows a company to tap into a wide pool of potential investors to provide itself with capital for future growth, repayment of debt, or working capital. A company selling common shares is never required to repay the capital to its public investors. Those investors must endure the unpredictable nature of the open market to price and trade their shares. After the IPO, when shares trade freely in the open market, money passes between public investors. For early private investors who choose to sell shares as part of the IPO process, the IPO represents an opportunity to monetize their investment. After the IPO, once shares trade in the open market, investors holding large blocks of shares can either sell those shares piecemeal in the open market, or sell a large block of shares directly to the public, at a fixed price, through a secondary market offering. This type of offering is not dilutive, since no new shares are being created.
Once a company is listed, it is able to issue additional common shares in a number of different ways, one of which is the follow-on offering. This method provides capital for various corporate purposes through the issuance of equity (see stock dilution) without incurring any debt. This ability to quickly raise potentially large amounts of capital from the marketplace is a key reason many companies seek to go public.
An IPO accords several benefits to the previously private company:
* Enlarging and diversifying equity base
* Enabling cheaper access to capital
* Increasing exposure, prestige, and public image
* Attracting and retaining better management and employees through liquid equity participation
* Facilitating acquisitions (potentially in return for shares of stock)
* Creating multiple financing opportunities: equity, convertible debt, cheaper bank loans, etc.
There are several disadvantages to completing an initial public offering:
* Significant legal, accounting and marketing costs, many of which are ongoing
* Requirement to disclose financial and business information
* Meaningful time, effort and attention required of senior management
* Risk that required funding will not be raised
* Public dissemination of information which may be useful to competitors, suppliers and customers.
The sale (allocation and pricing) of shares in an IPO may take several forms. Common methods include:
* Best efforts contract - In the best efforts contract the underwriter agrees to sell as many shares as possible at the agreed-upon price.
* Firm commitment contract - In the firm commitment contract the underwriter guarantees the sale of the issued stock at the agreed-upon price. For the issuer, it is the safest but the most expensive type of the contracts, since the underwriter takes the risk of sale.
* All-or-none contract - Under the all-or-none contract the underwriter agrees either to sell the entire offering or to cancel the deal.
* Bought deal - It occurs when an underwriter, such as an investment bank or a syndicate, purchases securities from an issuer before a preliminary prospectus is filed. The investment bank (or underwriter) acts as principal rather than agent and thus actually "goes long" in the security. The bank negotiates a price with the issuer (usually at a discount to the current market price, if applicable).
A company planning an IPO typically appoints a lead manager, known as a bookrunner, to help it arrive at an appropriate price at which the shares should be issued. There are two primary ways in which the price of an IPO can be determined. Either the company, with the help of its lead managers, fixes a price (fixed price method) or the price can be determined through analysis of confidential investor demand data, compiled by the bookrunner. That process is known as book building.
Stag profit is a stock market term used to describe a situation before and immediately after a company's Initial public offering (or any new issue of shares). A stag is a party or individual who subscribes to the new issue expecting the price of the stock to rise immediately upon the start of trading. Thus, stag profit is the financial gain accumulated by the party or individual resulting from the value of the shares rising.