Initial Public Offering

Initial Public Offerings (IPOs) are the first time a company sells its stock to the public. Sometimes IPOs are associated with huge first-day gains; other times, when the market is cold, they flop. It's often difficult for an individual investor to realize the huge gains, since in most cases only institutional investors have access to the stock at the offering price. By the time the general public can trade the stock, most of its first-day gains have already been made. However, a savvy and informed investor should still watch the IPO market, because this is the first opportunity to buy these stocks.

Reasons for an IPO

When a privately held corporation needs to raise additional capital, it can either take on debt or sell partial ownership. If the corporation chooses to sell ownership to the public, it engages in an IPO. Corporations choose to "go public" instead of issuing debt securities for several reasons. The most common reason is that capital raised through an IPO does not have to be repaid, whereas debt securities such as bonds must be repaid with interest. Despite this apparent benefit, there are also many drawbacks to an IPO. A large drawback to going public is that the current owners of the privately held corporation lose a part of their ownership. Corporations weigh the costs and benefits of an IPO carefully before performing an IPO.

Going Public

If a corporation decides that it is going to perform an IPO, it will first hire an investment bank to facilitate the sale of its shares to the public. This process is commonly called "underwriting"; the bank's role as the underwriter varies according to the method of underwriting agreed upon, but its primary function remains the same.

In accordance with the Securities Act of 1933, the corporation will file a registration statement with the Securities and Exchange Commission (SEC). The registration statement must fully disclose all material information to the SEC, including a description of the corporation,...