Going Public: How IPOs Work

How a private company sells shares to the public for the first time, why companies do it, and what it costs.

An initial public offering, or IPO, is when a private company sells shares to the public for the first time and lists them on a stock exchange. After an IPO, anyone can buy and sell the company’s shares.

Why companies go public

Companies go public for several reasons:

Raising money: selling new shares brings in cash to fund growth.
Letting early investors sell: founders, employees and venture capital investors can turn their shares into cash.
Visibility and credibility: being listed can raise a company’s profile with customers and lenders.
Using shares as currency: listed shares can be used to pay for acquisitions or reward employees.

How an IPO works

A company usually hires investment banks as underwriters. They help set the price, market the shares to investors and often guarantee to buy any shares not sold. The company publishes a prospectus, a detailed document describing its business, finances and risks, which must be approved by regulators such as the Securities and Exchange Board of India or the U.S. Securities and Exchange Commission.

Before the listing, the banks meet large investors to gauge demand, a process called a roadshow. The final price is set based on that demand.

The first-day pop

IPO shares often rise sharply on their first day of trading. Research by economists including Jay Ritter has found that U.S. IPOs have risen by around 15 to 20 percent on their first day on average over several decades. This means the company may have sold its shares for less than investors were willing to pay, leaving money on the table.

An IPO priced too low

A company sells 10 million new shares at 20 dollars each, raising 200 million dollars. On the first day, the shares close at 26 dollars. Investors who bought at the IPO price gained 60 million dollars on paper in a day. If the shares had been priced at 26 dollars, the company would have raised 60 million dollars more.

The costs of being public

Going public is expensive. Underwriters’ fees in the United States are often around 7 percent of the money raised for mid-sized IPOs. Listed companies must publish regular financial reports, follow stricter rules and face constant scrutiny from investors. Some companies choose to stay private for longer, raising money from private investors instead.

Thinking an IPO is a guaranteed win for investors

First-day gains get headlines, but ordinary investors often cannot buy at the IPO price, and studies suggest that many IPOs underperform the wider market over the following years. Buying shares after the first-day jump can be risky.

Key takeaways

An IPO is a company's first sale of shares to the public.
Companies go public to raise money, let early investors sell and gain visibility.
Underwriters set the price and market the shares, based on a regulator-approved prospectus.
IPOs often rise on the first day, but they are costly and many underperform later.