IPO (Initial Public Offering)

How IPOs WorkAt-and-t-wireless-profile.jpg
by Ed Grabianowski

Sometimes, the business report on the nightly news can sound like it's being given in a foreign language. Ask someone on the street if they've checked the EDGAR data for the Google IPO, and you'll likely get a blank stare.

IPOs are a very important aspect of the U.S. (and world) economy, and they've been around since the late 18th century. In fact, every company with stocks

In this article, we'll find out what an IPO is, why companies have them, and how people and companies make money with them.

What is an IPO?
IPO stands for Initial Public Offering. An IPO happens when a privately owned company issues shares of stock to be sold to the general public. This means the company is no longer privately owned, but is owned by a variety of investors , some of whom are not involved with the day-to-day operations of the company -- these investors simply own some of the company's stock, which they purchased on the open market. Although IPOs can vary greatly from one company to another, and they require a long, expensive and complicated process, the IPO is basically a way for the company to make money based on expectations of future success and profit.

The media's focus on high-profile technology IPOs and Internet-related stocks might lead one to think IPOs are somehow linked to the tech sector. In fact, even the most mundane company can have an IPO, and the first IPOs were held in the 1790s (they were called stock subscriptions at the time). A look at the top U.S. IPOs of all time shows few technology companies and no Internet businesses. Standouts include Pepsi Bottling Group, Kraft Foods, MetLife insurance company, international shippers UPS, and the biggest IPO in U.S. history, the wireless division of AT&T. The IPO for Internet search site Google didn't even approach the top 10, despite the media frenzy that surrounded it.

Why Have an IPO?
The obvious reason that any company has an IPO is to raise money. Why would a company need to raise money?

In the business world, there are as many reasons to raise money as you yourself might have. Think of a few of the reasons you might want to raise $1,000 -- to take a vacation, to pay for important surgery, to make repairs on your house, to invest in a business, or just to buy something you want. Businesses aren't that different, but they operate on a larger scale, and they have different needs and plans that require money. Some of more common reasons that a company might need money, or capital , include:

old equipment a new kind of business avoid paying the interest on them)    for the owner or original investors     investors rich
 * To buy new equipment or upgrade
 * To expand into a new region or
 * To pay back old debts (and
 * As an "exit strategy"
 * To make the original owners and

Upgrading and Expanding

The first two reasons are fairly obvious. Examples could include a bakery that is losing its share of the marketplace because of the low-carb fad. It could have an IPO to raise capital and buy the equipment it needs to make low-carb products and stay competitive. Or imagine a trucking company that is successful shipping along the west coast of the United States -- if it wants to expand its shipping into the Midwest and southwest, it'll need to buy more trucks, hire more drivers, and lease more warehouse space. An IPO could pay for all of these things.

Paying Debts

Using an IPO to repay debts makes a lot of sense if a large portion of the company's initial investment came from a bank loan. Every month, the company's profits are eroded by the interest it has to pay on that loan. There's no interest to pay on the money raised from an IPO; the company can use that money to repay the loan, and that profit-shrinking interest comes right off the balance sheet.

Exit Strategy and Financial Windfall

The last two reasons for having an IPO are closely related. When a company is privately owned, the founders, certain members of the management team (or all the employees, depending on the company) and private investors who helped fund the company all hold shares in the company. Those shares will have little value since they aren't publicly traded. After the company's IPO, those shares can increase in value by a huge margin. In short, anyone who has a lot of those shares could become very rich by selling them.

So what is an exit strategy ? Not everyone who starts a business wants to run it forever. Some business owners may just want to get the business going, make it profitable, and then sell their share in the company and move on. Some people do it because they enjoy the challenge of starting new companies. Some just want to get rich and then retire or repeat the process and get richer still. Either way, having an IPO can drastically increase the company's value and make it easier to sell a share in the company.

There are benefits to having an IPO other than raising capital. When a company's stock goes public, it can attract a lot of media attention. This amounts to free advertising for the company. Also, many publishers of stock market information list and track public companies, which means going public can get a company's name "in the books" and in front of investors and stock brokers.

Issuing shares allows employees to hold stock in a company. The employees know that their share of the company will increase in value the more successful the company is. This gives employees more pride in the work they do -- they literally become part owners. This effect can extend to interested business associates, as well. Imagine that the owner of a packaging business buys stock in the bakery we mentioned above when the bakery has its IPO. The packaging business supplies plastic bags to the bakery, so the owner might be willing to give the bakery a deal on the plastic bags in hopes of helping the bakery become more successful (and increasing the value of his stock).

The last benefit to an IPO has to do with rules established by the Securities Exchange Commission (SEC) that strictly regulate public companies to prevent fraud. To go public, a company has to open its accounting practices, sales figures, and marketing plans to anyone who wants to see them. This can make it easier for the company to secure certain kinds of loans and raise money from other investors.

The Drawbacks of an IPO
Having an IPO doesn't mean free money for the company. Otherwise, everyone would have an IPO. There are drawbacks that come with the new capital raised through an IPO.

The most obvious cost of having an IPO is the expense. It costs money to raise money. The legal fees, printing costs, and accounting fees associated with registering an IPO can run into the hundreds of thousands of dollars. On top of those costs, the rules for taking a company public are so complex that most companies have to hire experts to handle all the paperwork. And once the IPO has happened, the costs don't end. The SEC regulations on public companies mean that the CEO of the company will either have to devote a lot of extra time to dealing with those regulations (plus the demands of profit-hungry shareholders) or hire someone else to do it.

Speaking of shareholders , they are another drawback of going public. The primary owners are no longer in a private company that can make independent decisions. The investors who purchased stocks at the IPO own a certain percentage of the business, and their demands cannot be ignored, even if they don't have a controlling interest (more than 50 percent of the shares) in the company. SEC regulations require shareholder notification, meetings, and approval for certain business decisions. Shareholders also want to see the value of their stocks rise, so if the stock price drops or remains stagnant, the company will have to deal with unhappy part-owners. If they become unhappy enough, they may sell their stocks, which will cause the value to drop further, decreasing the overall value of the company.

Public companies are also open to public scrutiny. Quarterly financial reports, internal transactions, and balance sheets are all open to inspection. This is more of a problem for some companies than others, particularly companies who might have made illegal deals or altered financial reports. To learn about what happens when public scrutiny discovers improper financial dealings, read Open Spaces Quarterly: The Enron Debacle, by Steve McConnel.

Not Just Any Investor

When stocks are initially sold during an IPO, the company gets the money for the sale of the stocks no matter who buys them. However, in the long term, certain kinds of investors can be bad for the company's value. The "bad" kind of investors are speculators , who really don't want to invest in the company's future. They just want to buy shares cheap and sell them at a higher price to make a quick buck. This is known as flipping a stock, and while it isn't illegal, many brokerage firms discourage it by punishing traders who do it (usually by denying them access to future IPO opportunities).

Ready, Set, IPO
Having an IPO is not so much an event as it is a process. It takes months of planning to prepare a company to go public. A board of directors must be assembled, accounts audited for accuracy, consultants and advisers hired, and a financial printer contracted. In fact, a whole cast of characters must take the stage to help an IPO happen.

The most important character is probably the underwriter, an investment banker who works for an investment company. Underwriters have the distribution channels and business community contacts that can get a company's shares out to the right investors. They will also help set the initial offering price for the stocks, work to create enthusiasm for the stock, and assist in creating the prospectus. The prospectus is an important document that describes the company in great detail to potential investors.

Once the prospectus has been drafted, it is reviewed by the SEC. SEC approval only means that the prospectus follows the regulations for such documents -- it says nothing about the quality or future profitability of the company.

Following SEC approval, company executives go on the road show, otherwise known as the dog-and-pony show. This is a tour of major cities and cities where important brokerage houses have their headquarters. At these invitation-only slide shows (a few elite investors will even get one-on-one presentations), potential investors are given "goodie bags" containing calendars, pens, samples of the company's product, and whatever else might help investors think favorably about the company. One fashion designer even stocked a road show with famous supermodels.

Although the goodies and supermodels take the spotlight, the road-show crew also includes a Wall Street analyst who will give positive opinions about the company's future profitability. However, no one involved with the company is allowed to talk publicly about anything that isn't in the prospectus in the period leading up to the IPO (Google broke this rule in the weeks leading up to its IPO -- see The Google IPO section to learn more).

The Day of the IPO
The day before the stocks are issued, the underwriter and the company must determine a starting price for the stocks. A target price will have been set early on in the process, but IPOs are rarely stable. Obviously, the higher the price, the more money the company gets; but if the price is set too high, there won't be enough demand for the stocks, and the price will drop on the aftermarket (the open financial markets where the stock will be traded after the initial offering). The ideal stock price will keep demand just higher than supply, resulting in a stable, gradual increase in the stock's price on the aftermarket. This will lead to praise from market analysts, which will in turn lead to increased value down the road.

Who gets to buy the shares during an IPO is a complicated matter. In most cases, your typical, individual investor doesn't get access to these offerings (see The Google IPO to read about an exception). Instead, the underwriter gets to allocate the shares to associates, clients, and major investors of his choosing. Most of the shares (about 80 percent) will go to institutional investors, which are major brokerage firms and investment banks, and a few high-profile individual investors. The remaining shares that do make their way to small-time, individual investors are hard to obtain: Stock brokers usually only offer access to IPOs to higher volume traders, traders with no history of flipping stocks, and traders with a long-term relationship with the broker.

After the initial offering, the stocks hit the open stock market, where they begin trading at a price set by market forces. IPO stocks tend to trade at a very high volume on that first day -- that is, they change hands many times. Some IPOs can jump in price by a huge amount -- some more than 600 percent. Many IPOs do poorly, dropping in price the day of the offering. Others fluctuate, rising and then dipping again -- it all depends on the confidence the market has in the company, how strong the company is vs. the "hype" surrounding it, and what outside forces are affecting the market at the time.

After about a month, the underwriter issues a report on the IPO, which is always positive. This tends to give the stock a slight boost. After 180 days have passed, people who held shares in the company prior to its going public are allowed to sell their shares.

The Google IPO
The IPO of Internet search engine Google wasn't one of the biggest IPOs ever, but it was a media sensation. While many aspects of Google's IPO were standard, it differed in some important ways. Also, Google made some mistakes that affected its IPO.

The biggest difference was in the way Google chose to allocate shares. Instead of letting the underwriter dish out shares to favored institutions, Google held a Dutch auction in which everyone who wanted a share put in a bid. The lowest successful bid became the price that everyone got their shares at, even if they bid a higher amount. This method guarantees that the initial offering price is set to sell all of the shares at a price that conservatively reflects market demand.

Google's initial price range for the stocks was between $108 and $135 per share, a fairly high amount that was meant to scare off speculators. Several well-publicized problems with the IPO caused that price to drop, and by the time the Dutch auction had concluded, the official starting price was $85 per share.

What were the problems with Google's IPO? The first was an interview published in Playboy magazine. This violated SEC rules restricting comments that can be made about a company in the lead-up to an IPO. This could have delayed the IPO, but Google avoided this by admitting that misleading statements were made in the article and by issuing a revised prospectus that contained the entire Playboy article -- a move that probably cost them tens of thousands of dollars in printing costs.

The other mistake was a technical issue regarding the issuance of shares to employees before the IPO. The company failed to register those shares, forcing them to offer to buy them back. The SEC fines companies for this mistake.

However, Google's biggest "mistake" was not playing the usual Wall Street game. The Dutch auction method was meant to give individual investors a chance at the IPO instead of the usual bystander's role, watching from the sidelines as major investors and houses bought up all the shares. It worked, but it left the underwriters and the companies who usually profit from their mutual deals fuming. Google also paid the underwriters a fraction of the commission they usually earn. Since the value of a stock depends in part on the efforts of these Wall Street insiders to convince others of that value, Google's refusal to play ball surely had an effect on the stocks' valuation.

So how much money did the Google IPO make? For the company, it raised $1.67 billion , rising to a value of more than $100 per share in the days after the IPO. But here's another way to look at it: Google employees purchased shares for as little as $.30 per share when it was still a private company. Someone who had just 10,000 Google shares is now a millionaire.

10 of the Biggest IPOs in History
by Josh Clark|

A reporter waits for trading to begin on Facebook stock, minutes before its initial public offering on May 18, 2012.

Start the Countdown

Friday, May 18, 2012, was a big day for American tech giant Facebook. The social media behemoth made its initial public offering (IPO) -- its debut as a publicly traded company -- on the New York Stock Exchange that day. In just one day of trading, Facebook sold 421.2 million shares of itself to investors for $38 apiece, amassing a cool $16 billion in new capital just about instantly [source: Bel Bruno]. Facebook's IPO became the largest tech offering – and third largest overall -- in U.S. history.

In the parlance of global IPO history, however, this is peanuts.

Initial public offerings are as high as high finance gets. When a well-known, formerly private company goes public, investors clamor for shares. They already know the company's management, they know its earning history, its forecasts. In many cases, the only thing left to chance is how much higher the share price will go once trading begins.

They're also the result of months or years of work. Companies turn to investment banks to underwrite the offerings, vet buyers, scintillate the media and value the stock. When it goes right, an IPO can mean a sudden infusion of cash in the tens of billions in just a matter of hours for some companies.

What follows are 10 of the most successful IPOs (by one-day proceeds) in the history of the world.

10 AT&T Wireless
AT&T Wireless, the mobile division of American telecommunications monolith AT&T, just barely squeaked in its IPO before the dot-com bubble burst. The stock market began to slide in mid-March 2000, and AT&T Wireless released its initial public offering on April 26. Other tech companies withdrew their IPOs, but AT&T gambled and went ahead with its offering. It paid off.

The wireless division's affiliation with its well-known parent certainly didn't hurt its prospects. When trading began on the NYSE, AT&T Wireless released 360 million shares. Investors fell in step with underwriters' valuation of the stock, with shares opening at $30.12 and closing at $31.75; its pre-offer value was $29.50 [source: Portnoy and Jastrow].

By the time the bell rung to close the day on the exchange, AT&T Wireless had raked in $10.62 billion in new capital [source: BusinessWeek]. It set the record for the largest IPO in American history, a title the company would hold for six years.

9 OAO Rosneft
Always one to buck the global trend, Russia did it again when it took OAO Rosneft -- the state-owned oil company -- public. While many other large IPOs were the result of the privatization of a state-owned entity, OAO Rosneft was Russia's share sale of its own company. What's more, Russia had put the oil giant together through seized assets from private enterprises operating in the country.

A number of financiers balked at the IPO, considering it unethical. This didn't stop Russia from offering the stock -- and other investors on the Moscow and London exchanges from buying it. When OAO Rosneft went public on July 13, 2006, it attracted $10.65 billion in capital, with shares underwritten by bankers like JPMorgan and Morgan Stanley [source: BusninessWeek].

OAO Rosneft released 1.38 billion shares of itself, valued at $7.55 apiece [source: Bloomberg]. The IPO fell about $1 billion short of the company's hope to raise $11.6 billion.

8   Bank of China
The Bank of China released almost 26 billion shares during its 2006 IPO. Investors snatched them up quickly.

The Bank of China (BOC) was a state-owned bank until it was spun off into a publicly traded private lender during its IPO on May 23, 2006. The one-day total for purchases for shares ahead of the listing on the Hong Kong exchange the following week -- attracting everyone from the bank's everyday account holders to European banks like Royal Bank of Scotland -- topped $9.7 billion [source: Lague]. When the final tallies were in, the BOC raked in a whopping $11.1 billion during its IPO [source: BusinessWeek].

The bank issued 25.57 billion shares, comprising just 10.5 percent of the BOC, at the equivalent of about 38 cents apiece [source: Lague]. The shares sold rapidly, despite reports of 75 cases of fraud and corruption among the bank's leaders the year before. All told, Bank of China's IPO was the biggest offering in six years.

== 7 Deutsche Telekom AG ==

Deutsche Telekom has become one of the world's leading mobile service providers, thanks in part to its $12.48 billion 1996 IPO.

When German telecommunications giant Deutsche Telekom AG issued its IPO on Nov. 17, 1996, it was the largest in European history. The company that spawned T-Mobile released more than 713 million shares of itself. By the end of the day, Deutsche Telekom had raised $12.48 billion [source: BusinessWeek].

Trading on the European exchange began on Nov. 17, 1996, and raised the value of the stock to $22.45. Investors who bought the stock as trading began and sold it an hour later made a 19 percent profit for their trouble [source: Ascarelli].

Trading of what came to be one of the hottest telecom stocks in Europe at the beginning of the dot-com bubble was heavy. It was so heavy, in fact, that the European exchange extended their daily trading hours until 7 p.m. for a full week following Deutsche Telekom's IPO [source: Ascarelli].

6   GM
The General Motors headquarters building in Detroit. The giant automakers announced the largest profits in its history -- some $7.5 billion -- in February 2012.

When do the taxpayers benefit from an IPO? When a company that owes its life to a federal bailout goes public in a big way.

In December 2008, President George W. Bush threw a $50 billion lifeline to General Motors, which had been struggling (along with other American automakers) in the wake of the global economic downturn that started in 2007. Unfortunately, that assistance didn't do much to keep GM from filing for Chapter 11 bankruptcy in June 2009. As part of the company restructuring that usually follows a Chapter 11 filing, the U.S. Treasury Department agreed to loan the company another $30 billion -- in exchange for a 60-percent stake in the company once it got back on its feet [source: ProPublica]. By the following month, the newly reformed GM was ready to start operations once more.

By the following year, GM was one of the hottest companies on the planet. Investors couldn't wait to buy their way in -- and the company knew it: Less than a week before its November 2010 IPO, the company's shareholders raised the estimated share price from between $26 and $29 per share to between $32 and $33 a share [source: Isidore]. When GM finally went public on Nov. 19, 2010, the automaker raised a staggering $15.8 billion, making it the second-largest IPO in U.S. history. That cash infusion helped GM repay nearly half of its initial $50 billion bailout, which resulted in nearly $700 billion in federal revenue [source: ProPublica]. That should make the taxpayers very, very happy.

5 Enel SpA
Enel, one of Europe's leading energy providers, exchanged 31.7 percent of itself for more than $16.5 billion during its 1999 IPO.

You may not have heard of Italian energy company Enel SpA, but you may have gotten power from them at some point. The company has a presence in 23 countries in Europe, North and South America and Asia. It's the second largest energy company in Europe and it has a customer base of 60.5 million -- about the population of the entire United Kingdom [sources: Enel SpA, BBC]. The company is also well-known as a pioneer in green energy, with investments in hydroelectric, geothermal, solar, wind and biomass power generation.

It seems that none of this was lost on investors when Enel SpA went public on Nov. 2, 1999. The formerly state-owned company was privatized just ahead of Italy's move to adopt the euro as its currency. Its IPO of 31.7 percent of the publicly traded company (3.8 billion shares) raised $16.58 billion in capital for the firm, representing 10 percent of the value of the Milan-30 blue chip business index [source: BusinessWeek]

4 Visa
Ever since the consortium of banks that issued the first Visa card in 1977 became Visa International, investors chomped at the bit for the privately held American credit card giant to go public. They would have to wait 31 years before they got the chance. When Visa finally went public in March 2008, everyone expected a huge windfall for the company. Everyone was right.

On Tuesday, March 18, 2008, Visa made its initial public offering on the New York Stock Exchange. Despite going public amid the beginning of the global financial crisis, Visa managed to rack up $17.9 billion in capital. By the end of the day, the company's stock traded at $44 a share [source: Benner]. The following day, it traded at $66 [source: Kaufman].

One reason Visa's IPO was so successful was the scrupulousness with which underwriters JPMorgan and Goldman Sachs eyed buyers. The bankers vetted out investors who might have flipped the shares they bought. Quick resales would have harmed the company's capital accumulation, since the market could have become flooded with already-purchased stocks.

Visa's IPO marked the largest in U.S. history at the time, demolishing AT&T's six-year-old record of $10.6 billion.

3 NTT Mobile Communications Network
When NTT Mobile Communications, a giant in Japanese wireless phones, went public on the Nikkei 225 average on Oct. 12, 1998, the Asian market was dull. The offering of stock in the company managed to bring the market back to life, however. Ten days after NTT Mobile's IPO, the Nikkei average had added 1,300 points to its 14,295 total in just a five-day span [source: WSJ]. While other Asian markets were embattled, the IPO kept the Nikkei chugging along.

The initial pre-offering value for shares in the company was 3.9 million yen; by the end of the day, they had risen to a close of 4.65 million yen. By the time the bell had rung to end the day on the Nikkei, NTT Mobile had amassed $18.4 billion in capital -- in one day. It was the largest IPO in world history [source: NYSE].

Not a bad stock to purchase considering just over a decade earlier NTT Mobile's parent company, Nippon Telegraph and Telephone, had managed to raise more than $13 billion during its own IPO in 1986.

2 Industrial and Commercial Bank of China
The concept of the 2000s being the Chinese century got a shot in the arm on Oct. 20, 2006, when the Industrial and Commercial Bank of China (ICBC) made its public debut on the Hong Kong and Shanghai markets. The company raised the most ever in global history during an IPO, an incredible $19.1 billion [source: BusinessWeek]. That amount is more than the total value of all the shares in existence (called market cap ) for the Bank of Ireland. By contrast, the market cap for ICBC was $140 billion, which made it the fifth largest bank in the world [source: Mann].

Rather than introduce a limited number of shares at a high price, the bank created 48.39 billion shares at about 39 cents apiece. Demand for futures contracts (agreements to buy or sell stock at a later date) for the shares topped $500 billion, which would have made it twice as valuable as Citigroup, the largest bank in the world at the time [source: Chan].

Investors had good reason to pour their money into ICBC. The bank's retail customer base -- everyday people who hold accounts and investments in ICBC -- at the time of its IPO was 153 million, or 10 million more people than the entire population of Russia [source: Chan].

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== 1 The Agricultural Bank of China ==

The massive IPOs for two of China's biggest banks -- the Bank of China and the Industrial and Commercial Bank of China -- proved that the growth of the Chinese economy was no fluke. But who would've thought that yet another bank offering would trump both?

The Agricultural Bank of China (ABC) started off humbly, founded by Mao Zedong as a resource for rural farmers, but it hit the big time on July 6, 2010, raising $19.2 billion in a single day to become the biggest initial public offering in history. By the end of the day's trading, the once-humble bank was worth about $128 billion – more than Citigroup and Goldman Sachs [source: Wines].

ABC was the last of China's four largest banks (the last being the China Construction Bank) to go public. Although the initial stock offering took a bit of a hit due to concerns about the durability of China's economy and a slew of Chinese bank bailouts, ABC's triumph continued China's hot streak in the IPO world. According to The New York Times, more than one-third of the new IPOs came from Chinese companies -- a significant increase from the quarter that that came from the country the previous year. What does this mean for China? It's still too early to tell, but it's worth noting that both Morgan Stanley and Goldman Sachs have bet big on the Chinese bank [source: Lee].