An initial public offering, or IPO, is a common way that a firm goes public and sells shares to raise financing. There are two common types of IPOs: a fixed price and a book building offering. A company can use either type separately or combined. By participating in an IPO, an investor can buy shares before they are available to the general public in the stock market.
Fixed Price Offering
Under fixed price, the company going public determines a fixed price at which its shares are offered to investors. The investors know the share price before the company goes public. Demand from the markets is only known once the issue is closed. To partake in this IPO, the investor must pay the full share price when making the application.
Book Building Offering
Under book building, the company going public offers a 20% price band on shares to investors. Investors then bid on the shares before the final price is settled once the bidding has closed. Investors must specify the number of shares they want to buy and how much they are willing to pay. Unlike a fixed price offering, there is no fixed price per share. The lowest share price is known as the floor price, while the highest share price is known as the cap price. The final share price is determined using investor bids.
Participating in an IPO
When participating in an IPO, there are several details an investor should know, such as the issue name, issue type, category, and price band, to name a few. The issue name is the firm going public. The issue type is the type of IPO: fixed-price or book building. There are three IPO categories: retail investors, non-institutional investors, and qualified institutional buyers. The price band is the price range determined for book building issues. Not all retail brokers offer IPOs to their clients, and so IPOs are usually allotted to qualified or institutional investors first. IPOs also can tend to be riskier than established stocks since they do not yet have a track record of performance or a history of publicly available financial statements that can be analyzed.
When a firm decides to go public, it must hire an investment bank to take care of the IPO. Although a company could go public on its own, it rarely happens. A firm can hire one or more investment banks to handle its IPO. By hiring more than one bank, the risk is spread between the banks, which place their bids for the IPO with the amount of money they anticipate earning. This process is referred to as underwriting.
When the firm going public and the investment banks come to an agreement on the underwriting, the banks prepare a registration statement that must be filed with the U.S. Securities and Exchange Commission, or SEC. The statement contains important financial information on the IPO, including financial statements, names of the board of directors, legal issues and how the financing is to be used. Once the SEC reviews the paperwork, it determines the date of the IPO.