Introduction
An Initial Public Offering (IPO) is one of the most exciting moments in a company’s history. It marks the transition from being privately owned to becoming publicly traded, allowing anyone to buy shares in the business for the first time.
Many well-known companies, including Amazon, Google, and Airbnb, started their journey on the stock market through an IPO. These events often attract significant media attention because investors hope to buy into the next successful company before it grows even larger.
For beginners, however, IPOs can seem confusing. Why do companies decide to go public? Who determines the share price? And is buying an IPO actually a good investment?
In this guide, you’ll learn how IPOs work, why companies choose to go public, and what investors should consider before buying newly listed stocks.
What is an IPO?
An Initial Public Offering (IPO) is the first time a private company offers its shares to the general public through a stock exchange. Before an IPO, ownership is typically limited to founders, employees, venture capital firms, and other private investors. After the IPO, anyone with a brokerage account can buy shares.
Going public allows a company to raise money by selling new shares to investors. In return, shareholders receive partial ownership of the business and can benefit if the company grows in value over time.
Once the shares begin trading on a stock exchange such as the New York Stock Exchange (NYSE) or Nasdaq, their price is determined by supply and demand. From that moment on, the company’s financial performance and market sentiment play an important role in determining its stock price.
An IPO is often considered a major milestone because it gives companies access to a much larger pool of capital while opening the door for public investors to participate in their future growth.
Why do companies go public?
Going public is a significant decision that offers several advantages for a growing business. While raising money is often the primary reason, it is rarely the only one.
Raise capital
The biggest reason for an IPO is to raise funds. Companies can use this capital to expand into new markets, develop new products, hire employees, or invest in research and technology.
Increase visibility
Public companies receive far more attention from investors, financial media, and customers. This increased exposure can strengthen a company’s reputation and make it easier to attract new business opportunities.
Reward early investors
Founders, venture capital firms, and early investors often own shares long before a company goes public. An IPO creates an opportunity for these investors to sell part of their holdings and realize the value of their investment.
Attract talented employees
Many public companies offer stock-based compensation to employees. Since publicly traded shares are easier to value and trade, they can become an attractive part of an employee’s compensation package.
How does an IPO work?
Although IPOs often make headlines on a single day, the process usually takes several months to complete.
1.
The company decides to go public
The company’s management and board of directors determine that raising capital through the public market is the best next step.
2.
Investment banks are selected
The company hires one or more investment banks, known as underwriters, to help manage the IPO. These banks assist with pricing the shares, preparing legal documents, and marketing the offering to investors.
3.
Regulatory filings
Before shares can be sold, the company must submit detailed financial information to regulators. These filings provide investors with important information about the company’s business, risks, and financial performance.
4.
Pricing the IPO
Based on investor demand and the company’s financial outlook, the underwriters determine an offering price for the shares.
5.
Shares are allocated
Before public trading begins, many shares are allocated to institutional investors such as pension funds, mutual funds, and investment firms. Some brokers also make a limited number of shares available to retail investors.
6.
Trading begins
On the listing day, the shares begin trading on a stock exchange. From that point onward, the market determines the stock price based on supply and demand.
What happens on IPO day?
IPO day is often accompanied by excitement and significant price movements.
Although a company announces an IPO price before trading starts, the opening market price can differ considerably. If demand is very strong, buyers may be willing to pay more than the original offering price. If demand is weaker than expected, the stock may open below its IPO price.
This is why IPOs are often more volatile than established companies. During the first few trading days, investors are still determining what they believe the company is worth.
For long-term investors, it’s important not to focus solely on the first day’s performance. Some successful companies experienced disappointing IPOs before delivering excellent returns over many years, while others surged on day one but later declined significantly.
Can individual investors buy IPO shares?
Yes, but gaining access to IPO shares isn’t always easy.
Before public trading begins, many shares are reserved for large institutional investors. Individual investors typically receive only a small allocation, if any.
Some brokerage firms allow eligible clients to participate in IPO offerings. Requirements vary by broker and may include maintaining a minimum account balance or meeting certain investment criteria.
If you don’t receive IPO shares, you can still buy the stock once it starts trading on the exchange. Many investors prefer this approach because they can observe how the market values the company before investing.
Advantages and disadvantages of IPO investing
Like every investment, IPOs come with both opportunities and risks.
Advantages
Opportunity to invest early
Buying shares shortly after a company goes public allows investors to participate in its future growth from an early stage.
Access to innovative businesses
Many IPOs involve fast-growing companies operating in industries such as technology, healthcare, or renewable energy.
Potential for strong returns
Some IPOs have delivered exceptional long-term returns for investors who held their shares for many years.
Disadvantages
High volatility
Newly listed stocks often experience large price swings during their first weeks or months of trading.
Limited public track record
Unlike established public companies, newly listed businesses have less publicly available financial history for investors to analyze.
Valuation uncertainty
Determining whether an IPO is fairly priced can be difficult because there is limited market data available before trading begins.
Hype can influence prices
Popular IPOs often receive extensive media attention, which may drive prices higher than the company’s fundamentals justify.
IPO vs. direct listing vs. SPAC
Although IPOs are the most common way for companies to enter the stock market, they are not the only option.
| Feature | IPO | Direct Listing | SPAC |
|---|---|---|---|
| Purpose | Raise capital by issuing new shares | Allow existing shareholders to sell their shares directly | Become public by merging with an already listed shell company |
| New shares issued | Yes | Usually no | Usually yes |
| Raises new capital | Yes | Usually no | Yes |
| Role of investment banks | Investment banks act as underwriters | Investment banks usually have a limited advisory role | No traditional IPO underwriting process |
| Initial share price | Determined before trading begins | Established by market supply and demand | Based on the terms negotiated during the merger |
| Existing shareholders | May be restricted by a lock-up period | Can generally sell shares when trading begins | May be subject to lock-up agreements |
| Typical costs | Generally the highest | Usually lower than an IPO | Can still be significant |
| Time to become public | Usually several months | Usually several months | Can be faster than a traditional IPO |
| Best suited for | Companies seeking to raise substantial capital | Established companies that do not need significant new funding | Companies looking for an alternative route to the public market |
An IPO remains the most common route because it allows companies to raise substantial amounts of new capital while benefiting from the support of investment banks throughout the listing process.
Famous IPO examples
Many of today’s largest companies once completed an IPO.
- Amazon (1997) went public at an adjusted price of just a few dollars per share. Although the stock experienced significant volatility, long-term investors were rewarded with extraordinary returns.
- Google (2004) introduced an unusual auction-based IPO and has since grown into one of the world’s largest technology companies.
- Facebook (2012) had a difficult first few months as a public company, but eventually became one of the largest businesses in the world.
- Airbnb (2020) went public during the COVID-19 pandemic and experienced extremely strong investor demand despite uncertainty in the travel industry.
These examples demonstrate that an IPO’s first-day performance does not necessarily predict its long-term success.
Should you invest in IPOs?
IPOs can offer exciting investment opportunities, but they also involve more uncertainty than many established companies.
Instead of investing simply because a company is receiving media attention, take time to understand its business model, financial health, competitive position, and long-term growth prospects. Reading the company’s prospectus and comparing it to similar businesses can help you make a more informed decision.
For many beginner investors, waiting until the excitement surrounding an IPO has settled may be a sensible approach. By then, the market has had time to evaluate the company’s valuation, making it easier to decide whether the investment fits your long-term strategy.
Ultimately, an IPO is simply the beginning of a company’s journey as a public business. Whether it becomes a successful long-term investment depends on its ability to grow, innovate, and create value for shareholders over time.