An IPO, or initial public offering, is the event that brings a company into the stock market. When an IPO takes place, investors are able to buy the company’s stock on a major market, such as the New York Stock Exchange or NASDAQ. There are many reasons for a company to go through the IPO process, or avoid an IPO, and the mechanics of the process are fairly complex.
When small companies are looking to grow, they need money. There are several methods for raising funds. First, a company will look for an angel investor or venture capital funding. Those funding sources can help small companies build up revenues and, hopefully, reach profitability.
To scale up further, the company will generally need debt or equity financing. Debt, in the form of loans or bonds, has to be repaid with interest. Equity allows investors to put money into the company for an ownership stake. The stock issued does not have to be paid back, but the managers will have to act in the interest of shareholders once the stock has been issued. You might also be interested to see what a share of stock represents.
To issue stock, the company approaches a large investment bank that acts as a lead underwriter for the transaction. Examples of investment banks are Goldman Sachs and Morgan Stanley. Large financial institutions such as Bank of America and Citibank also have investment divisions.
The investment bank then undertakes a lengthy, detailed review of the company’s financial situation, growth potential, and value. Based on that value, the investment bank, or group of investment banks depending on the size of the company, will come up with a target price and number of shares.
The underwriting banks enter into a contract that requires the bank to pay the company the value of the initial public offering and sell the shares to investors. If you are interested in investing in an IPO, check with your stock broker. My brokerage firm only allows high net worth investors to buy into an IPO.
Tesla Motors IPO
Tesla Motors, which builds high end electric motor sports cars, is planning to have an IPO on June 29th. The IPO share price will be announced just before the stock begins trading, and investors have to commit to purchasing the shares ahead of time, without knowing the exact price. Rather, they are given a price range and prospectus explaining the risks of the investment. The range for Tesla is $14-$16 per share. At $15 per share, Tesla is a $1.4 billion company. The IPO will generate about $160 million for the company to use for further growth.
For a company that has never had a profitable year, this is a risky investment. If you have never seen what Tesla cars can do, take a look at the Tesla Motors website. The 288 horsepower Tesla Roadster can go from 0 to 60 in 3.7 seconds and has a top speed of 125 miles per hour, which is electronically imposed. (It could go 193 mph otherwise)
While the IPO will make the owners and early stage investors very rich, hopefully the company will put its new $160 million capital infusion to good use and build up a successful electric car company. The economy could use a new car company and the environment could really use electric cars (as long as we are off of coal power plants, which we are a long way from).
Image by Dominic's pics / flickr
Get the FREE Personal Profitability Playbook
Earn more, spend thoughtfully, grow your wealth, and live a better life through mindful personal finance.