IPOs Explained: How Companies Go Public and Should You Invest?

Going Public

An Initial Public Offering (IPO) is the process by which a private company sells shares to the public for the first time. It's a major milestone — the company transforms from being owned by founders, employees, and venture capitalists to being owned by anyone with a brokerage account.

Why Companies Go Public

• Raise capital — The primary reason. The company sells new shares and receives the cash directly, which can fund expansion, R&D, acquisitions, or debt repayment.
• Liquidity for early investors — Founders, employees, and venture capitalists can finally sell some of their shares and turn paper wealth into real money.
• Currency for acquisitions — Publicly traded stock can be used to acquire other companies.
• Prestige and visibility — Being publicly traded brings media attention, brand awareness, and credibility with customers and partners.

The IPO Process

1. Hire underwriters — Investment banks (Goldman Sachs, Morgan Stanley, JPMorgan) manage the IPO. They determine the offering price, market the shares to institutional investors ("roadshow"), and guarantee the sale of a certain number of shares.
2. File the S-1 — A detailed regulatory filing with the SEC that discloses the company's business, financials, risks, and how it plans to use the IPO proceeds. Every investor considering an IPO should read the S-1 — it's the most comprehensive look at the company you'll ever get.
3. Price the offering — The night before trading begins, the underwriters and company set the final IPO price based on investor demand during the roadshow.
4. First day of trading — The stock begins trading on an exchange. The "IPO pop" — the first-day price jump — reflects the difference between the IPO price (what institutional investors paid) and what the public market is willing to pay.

Should You Invest in IPOs?

For retail investors, IPOs are risky and often disappointing:

• You don't get the IPO price — The IPO price is reserved for institutional clients of the underwriting banks. Retail investors buy on the open market, typically after the stock has already popped 20-50%.
• Lock-up periods — Insiders and pre-IPO investors are typically prohibited from selling for 90-180 days after the IPO. When the lock-up expires, a flood of shares often hits the market, driving the price down.
• IPOs tend to underperform — Research by Professor Jay Ritter found that IPOs underperform the market by about 3-5% per year in the 3-5 years after going public. The initial hype fades, and reality sets in.
• Limited information history — Private companies disclose very little. You're making an investment decision with far less information than you'd have for a company that's been public for 10 years.

The safer approach: wait 6-12 months after an IPO. Let the hype settle, let the lock-up expire, let a few quarterly reports establish a track record. There's no rush.

Key Takeaways

• The IPO price goes to institutions, not retail investors. You're buying after the pop.
• IPOs historically underperform in the years after going public. The hype masks the risks.
• Wait 6-12 months before buying any newly public company. Let the dust settle.