What it means
An IPO does two things at once that are easy to confuse. The company can issue new shares, in which case the money raised goes into the business, and existing shareholders can sell some of their shares, in which case the money goes to them.
Most offerings combine the two, and the split is one of the first things a serious investor checks. The process takes six to twelve months in most cases and involves investment banks acting as underwriters, lawyers, auditors and a formal prospectus setting out the risks and financials.
Underwriters run a bookbuilding exercise in which they gauge institutional demand across a price range before setting the final offer price the night before trading starts. The costs are substantial and often underestimated.
Underwriting fees commonly run around 7% of the money raised for smaller deals, with legal, accounting and listing costs on top, and there is a permanent ongoing cost of being listed that many first-time boards fail to budget for. Life afterwards is different in ways that go beyond paperwork.
Results are reported to a fixed timetable, major decisions attract public commentary, and founders who once decided things over lunch now work through a board, a disclosure committee and a market announcement. Lock-up agreements typically prevent insiders selling for a period of around six months after listing.
Pricing is a genuine tension rather than a technical exercise. Price too low and the company has left money on the table when the shares jump on the first day, price too high and early investors nurse losses that make the next fundraising harder.
In practice
Real-world examples.
Example
A medical devices company with two approved products but no profits goes public to fund three clinical trials. Nearly all the shares sold are new, because the founders want the cash inside the business rather than in their own pockets.
Example
A profitable family-owned drinks brand lists partly to give three generations of shareholders a route to sell. Roughly half the shares offered are existing ones, and the prospectus states clearly how much of the proceeds go to selling shareholders.
Example
A logistics group prices its offering at the very top of the indicated range after strong institutional demand. The shares close 4% below the offer price on the first day, and the resulting criticism delays a planned secondary offering by a year.
Think of it
“Going public means starting to trade on an exchange-becoming a public company.
Formula
Calculation
Gross proceeds = new shares offered x offer price. Net proceeds = gross proceeds - underwriting discount - other offering costs. Market capitalisation at listing = offer price x total shares in issue after the offering.
A company with 50,000,000 existing shares issues 10,000,000 new shares at an offer price of $18.00, so gross proceeds are 10,000,000 x $18.00 = $180,000,000. An underwriting discount of 7% costs $180,000,000 x 7% = $12,600,000, and legal, audit and listing costs come to a further $4,400,000.
Net proceeds to the company are $180,000,000 - $12,600,000 - $4,400,000 = $163,000,000. Total shares after the offering are 50,000,000 + 10,000,000 = 60,000,000, giving a market capitalisation of 60,000,000 x $18.00 = $1,080,000,000, with new investors owning 10,000,000 / 60,000,000 = 16.7% of the company.Case study
Seen in the real world.
The following is a fictional, illustrative example. Verity Grain Foods, an invented breakfast cereal maker, had grown to $310,000,000 of revenue and needed roughly $150,000,000 to build a second production facility. Its board weighed bank debt against an IPO and chose to list, partly for the capital and partly to give two retiring founders a way out.
The illustrative preparation took ten months and surfaced problems nobody had anticipated: three years of audited accounts had to be restated onto a consistent basis, a related-party lease with a founder's property company had to be renegotiated at market rates, and two independent directors had to be recruited. The finance team grew from six people to fourteen before a single share was sold.
In the fictional outcome, Verity raised $164,000,000 net at a valuation the board considered fair, and the new factory opened two years later. The chief executive's stated regret was underestimating how much of her own time the quarterly reporting cycle would consume once the celebration was over.
Watch out
Common mistakes.
- Assuming all the money raised in an IPO goes into the company, when a large share can go to selling shareholders instead.
- Budgeting only for the underwriting fee and ignoring the permanent annual cost of being a listed company.
- Treating a first-day share price jump as a pure success, when it also means the company sold its shares more cheaply than the market would have paid.
Questions
People also ask.
How long does going public take?
Typically six to twelve months of preparation once the decision is made, and considerably longer if the accounts or governance need work first.
Can insiders sell their shares immediately?
Usually not, because lock-up agreements commonly restrict sales by founders, directors and early investors for around six months after listing.
Is an IPO the only way to list?
No, alternatives include a direct listing, where no new shares are issued, and a merger with an already listed shell company.
From the founder's library
Take it further with the book.
Build your financial confidence beyond this definition. Shihan's full-length guide, Accounting Fundamentals, takes the same plain-English approach and turns it into a complete, practical playbook for non-finance managers, business owners and students - with chapter-end quiz answers and presentation slides included.
25% off with code MMHQ25, applied at checkout. Priced in USD - checkout may show the equivalent in your local currency.
View the book and save 25%