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Why Would A Company IPO?

The City University London Sector Awareness Representatives have been running a commercial awareness month throughout March.  Please see below part of the winning answer to the question “why would a company make an initial public offering?”.

An Initial public offering [IPO] is a liquidity event, where a private company intends to offer the shares within the company to the stock market for the first time, with the aim of raising capital at the price of offering equity to the future shareholders[1].

The offer is generally disclosed to the potential shareholders in a prospectus, a memorandum issued by the company, to the preferred shareholders containing an assessment of the share price and initial value of the stock, after that the offer then extends to the general public. Noteworthy is the risk a preferred investor bears, when he decides on whether to invest or not as the situation once the shares are offered to the public is a reflection of volatile stock exchange market.

The risk the company faces is that the offering will be a bust and no money will be raised, which would mean the end of the company. This, however, can be prevented by an effective management and correct assessment of the share IPO share price.

The reasons for a company wanting to go public, outweighing the minuses, can be:

  • Enlarging and diversifying shareholder base
  • Attracting and retaining better management and employees through liquid equity participation
  • Attract acquisition
  • Provide for financing opportunities: equity, convertible debt, cheaper bank loans, etc. as the shares represent a security

The Sources of the shares which will be offered could either be from the standing shareholders of the company who will get the money raised by the IPO. For example a family business, where the shareholders will give up their equity, in order to bring capital in. Or the shares can be newly issued by the company.

The most burning issue for a company intending to go public, ultimately deciding between failure or success of the IPO, is how to set the price of the shares? If the price is not set adequately it may end up as a disaster as was seen on an example of Facebook or can end up in a successful IPO as in the case of Twitter. Ideally, the firm wants to sell the shares at a lower price than the actual value of the shares would be at the moment of the company going public, in order to attract share purchasers.

Shares are usually sold in “lots” of 100 with any other number being called an “odd lot” and are generally bought in multiples of 100 with an extra being paid for an odd lot purchase. The price is deduced from the so called “PE ratio” a ratio of price to earnings. Outstanding shares are split into smaller shares and though they are considered to be neutral, they usually are split so that they have a positive impact on the market and raise the value of the standing shares, instead of negative effect which would lower the price. The splits are usually on the ratio of 2/3:1. The shares are usually sold on the price range of anywhere between 5 – 100 USD, depending on the factors relevant to the company offering the shares[2].

By Jan Sleis, David Sinton, Yana Usherenko-Fialkova, Alicia Spinks


[1] Blacks Law dictionary, 9th edition, 2009, IPO, obtained through Westlaw UK.