With several high-profile initial public offerings expected in the coming quarters, many investors are asking how IPOs work and how they should evaluate participation.

This series addresses three questions: What is an IPO and how does it work? What has the recent IPO market looked like? And what should investors consider before participating?

What Is an IPO?

An initial public offering, or IPO, is the first sale of a company’s shares to public investors. Through this process, a privately held company becomes publicly traded, with shares listed on an exchange and available to a broader set of investors.

Private companies are typically owned by founders, and early investors. Their shares do not trade on public exchanges. Public companies, by contrast, have shares listed on exchanges such as the New York Stock Exchange or Nasdaq, which allow for any market participant to buy and sell the shares through a brokerage account.

Why Companies Go Public

Going public can offer several advantages. Companies can raise equity capital to fund growth, repay debt, or invest in new initiatives. Existing shareholders can gain an opportunity to sell a portion of their holdings. Public companies can also benefit from increased visibility and investor awareness.

These benefits come with trade-offs. Public companies face regulatory requirements, ongoing disclosure obligations, and greater scrutiny from investors, analysts, and regulators.

Primary vs. Secondary Markets

An IPO is a primary-market transaction. Shares are sold by the company, and sometimes existing shareholders, to investors before trading begins on an exchange. This initial sale does not occur on the open market. Underwriters, typically large investment banks, lead the process.

After the offering is completed, shares begin trading on an exchange in the secondary market. At that point, prices are determined by supply and demand. This is where many investors first gain access to the stock.

Types of IPO Structures

The traditional IPO remains the most common path to going public, but investors may encounter several structures.

Traditional IPO:

Investment banks underwrite the offering, market shares to institutional investors and help set the initial price. Shares are allocated before public trading begins.

Direct Listing:

A company lists its shares on an exchange without traditional underwriting. Existing shareholders sell shares directly into the market and pricing is determined once trading begins.

SPAC Merger:

A private company can go public by merging with a special purpose acquisition company, or SPAC, that is already publicly listed. This structure has different pricing, governance, and disclosure considerations.

The IPO Process

The IPO process typically begins well before any public filing. The company works with legal advisers, auditors and investment banks to prepare financial statements, refine its business narrative and assess readiness for public reporting.

The company then files a registration statement, typically Form S-1, with the Securities and Exchange Commission (SEC). This document includes disclosures about the company’s business, financials, risks, and intended use of proceeds. The SEC reviews the filing and may issue comments that the company must address.

Once the filing process is sufficiently advanced, the company and its underwriters market the offering to institutional investors through a roadshow. Management presents the company’s strategy and outlook, investors provide feedback on valuation and demand, and underwriters build an order book of potential buyers.

Based on investor feedback, underwriters determine the final offering price and number of shares to be sold. Inputs include investor demand, market conditions, comparable company valuations, and the company’s capital needs. Shares are then allocated, primarily to institutional investors. Retail participation at this stage is often limited.

After shares are sold at the offering price, trading begins on a public exchange. The opening price may differ materially from the IPO price. Trading can be volatile, particularly in the first several days.

Media coverage often focuses on the “first-day pop,” but that figure reflects the difference between the offering price and the initial trading price. It does not necessarily represent the return available to all investors.

Lock-Up Periods and Post-IPO Dynamics

After an IPO, insiders such as founders, employees, and early investors are often subject to a lock-up period, most commonly 180 days, during which they cannot sell their shares.

When the lock-up expires, additional shares may enter the market. This can increase selling pressure and volatility. Over time, the company is generally evaluated less on IPO demand and more on fundamentals such as earnings, growth, cash flow, and execution.

Key Takeaway

The IPO process is designed to raise capital and establish a public market for a company’s shares. Different participants can have very different experiences depending on pricing, allocation and timing.

For investors, the important question is not whether an IPO is exciting. It is whether the investment fits their goals, risk tolerance, time horizon, and broader financial plan.

*See Disclosures