IPO is an acronym for Initial Public Offering. This is the first sale of stock by a company to the public. For this reason, doing an IPO is also referred to as “going public”. A company can raise money by issuing either debt (bonds) or equity. If the company has never issued equity to the public, it is known as an IPO.
Going public raises cash, and usually a lot of it. Being publicly traded also opens many financial doors:
- Because of the increased scrutiny, public companies can usually get better rates when they issue debt.
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- As long as there is market demand, a public company can always issue more stock. Thus, mergers and acquisitions are easier to do because stock can be issued as part of the deal.
- Trading in the open markets means liquidity. This makes it possible to implement things like employee stock ownership plans, which help to attract top talent.
Being on a major stock exchange caries a considerable amount of prestige. In the past, only private companies with strong fundamentals could qualify for an IPO and it wasn’t easy to get listed.
The internet boom changed all this. Firms no longer needed strong financials and a solid history to go public. Instead, IPOs were done by smaller start-ups seeking to expand their business. There’s nothing wrong with wanting to expand, but most of these firms had never made a profit and didn’t plan on being profitable any time soon. In cases like this, companies might be suspected of doing an IPO just to make the founders rich. This is known as an “exit strategy”, implying that there’s no desire to stick around and create value for shareholders. The IPO then becomes the end of the road rather than the beginning.
How can this happen? Remember: an IPO is just selling stock. It’s all about the sales job. If you can convince people to buy stock in your company, you can raise a lot of money. IPOs like this are extremely risky and should be avoided.
“The stock market wake-up call is still ringing, but the lesson is clear. True value lies in P-E ratios, revenue and profit growth, and market size. That is what sets the value for the ultimate product - the company itself”. (Phillip L. Currie; appeared in the San Jose Business Journal, June 30, 2000)
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From Start-up to Ipo and Beyond