IPO (Initial Public Offering) financial models

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What is an IPO?

An IPO (or initial public offering) is stock being sold by a company to the public for the very first time. Before an IPO, the company is said to be private, with only a small number of shareholders that are mainly made up of early and professional investors. ‘The public’ is individuals that were not involved in the beginnings of the company, and that have an interest in purchasing company shares. The public cannot invest in a company until the company’s stock is offered for sale. If inclined, you could personally approach the owners of a private company and inquire about investing, but there is no obligation on their side to sell you anything. In comparison, a portion of the shares of public companies have been sold to the public to be traded on the stock exchange. It is for this reason that an IPO can also be referred to as ‘going public.’

Once a privately held company goes public, some of the company’s benefits are forfeited. When a company is private, it is not obligated to disclose much accounting or financial information about the company. Public companies however, are subject to strict regulations and have thousands of shareholders. They are required to form a board of directors, and auditable financial information must be reported every quarter. In the states, this is overseen by the SEC. As well as this, public companies are obligated to adhere to rules set forward by the stock exchanges where their shares have been listed. It is considered to be very prestigious to be listed on one of the major stock exchanges. In the past, it was difficult for a private company to qualify for an IPO, and you had to prove profitability and strong fundamentals. However requirements to be listed have now relaxed considering the increased competition among stock exchanges.

Why Have an IPO?

When then should you go public? If a goal for the company is to grow and expand, then going public will raise a great deal of money for the company. Private companies can raise capital by finding more private investors, borrowing money, or acquisition. But by a long run, IPO raises the biggest amounts of money for the company and its investors. Being traded publicly also opens a lot of opportunities financially. Due to the growing scrutiny from investors and analysts, public companies can usually benefit from lower interest rates when they issue debt. Additionally, as long as market demand exists, a public company is permitted to issue more stock in something known as a secondary offering. Therefore, mergers and acquisitions can be easier arranged because stock is able to be issued as a part of the deal.

For investors, liquidity is a result of trading in the open markets. As a shareholder of a private company, it can be very hard to sell your shares, and even harder to value them. A public company trades on a stock market which has ready sellers and buyers as well as a set price and transaction data. Therefore, the stock market is known as the secondary market as investors are selling and buying stock not from the company itself, but from other public investors. Liquidity and public markets also make it possible for a company to offer benefits like ESOPs, which can help in the search for top talent.

Advantages and Disadvantages of an IPO

Advantages:

  • You are exposed to a large and diverse number of investors to raise capital for your business

  • It provides the company with a lower cost of capital

  • The company’s prestige, exposure, and public image will be increased potentially leading to enhanced profits and sales

  • Through ESOPs, public companies are able to attract and retain better talent such as skilled management and employees

  • Acquisitions are facilitated

  • Compared to other options, this raises the most amount of money for the business

Disadvantages:

  • The company becomes obligated to disclose accounting, tax, and financial information

  • Increased costs which can be ongoing such as legal, marketing, and accounting

  • Increased effort, time, and attention is required due to reporting

  • There is a risk that the funding you need will not be raised if your IPO price is not accepted by the market. This will send your stock price lower immediately after the offering

  • You are required to disseminate your company’s information to the public which could be used by competitors

  • You give up a measure of control and gain agency problems due to new shareholders who now will have voting rights and can basically control company decisions through the board of directors.

  • There is more of a risk that you will encounter regulatory or legal issues.

If you’d like to read more about IPO’s, visit:

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