Most companies start as private — owned by founders, employees, and early investors. An IPO is the transition from private to public: the company sells newly-created shares (or existing investor shares, or both) to thousands of new investors, lists on a stock exchange, and must now report its finances publicly every quarter. It's a profound change in how a company operates.
Why companies go public
Companies IPO for several reasons, not all of them equally attractive to investors:
- Raising capital: New shares are issued, and the proceeds fund growth, debt repayment, or acquisitions. This is the most investor-friendly reason.
- Founder and investor exit: Early investors (VCs, private equity) sell their shares to cash out. The proceeds go to them, not the company. This is not a positive sign for incoming investors.
- Currency for acquisitions: Public shares can be used as acquisition currency — the company buys other businesses by issuing its own stock instead of cash.
- Talent retention: Public companies can offer stock options that vest over time, helping recruit and retain employees.
The IPO process
Investment banks (Goldman, Morgan Stanley, etc.) assess the company's value and take on responsibility for selling the shares. They earn 3–7% of proceeds.
The company discloses everything — financials, risks, business model, competitive landscape. The prospectus is a legal document investors can rely on.
Management presents to institutional investors across major cities. Orders are collected to gauge demand and help set the IPO price.
The IPO price is set (usually at the top of the indicated range if demand is strong). Institutional investors receive most allocations; retail investors receive less.
Shares begin trading on the exchange. The "opening pop" — price surging on the first day — is common but actually signals the IPO was underpriced.
The IPO performance puzzle
Research consistently shows two patterns: IPOs on average underperform the market over 3–5 years, but often surge on the first day. Why? Because investment banks deliberately underprice IPOs slightly to reward their best institutional clients with easy first-day gains — which makes those clients willing to participate in future deals. Retail investors who buy at the IPO price and hold often end up disappointed.
What this means for you
The excitement around IPOs is often inversely correlated with investor returns. The hottest, most hyped IPOs — where everyone wants in — tend to be the most overpriced. If you're allocated shares in a popular IPO, selling on the first day and capturing the opening pop has historically been better than holding. For less popular IPOs, the logic is even more important: if institutions didn't want shares at the IPO price, ask yourself why you should.
An IPO is when a company's earliest investors finally get to sell to someone. Make sure the someone isn't you at an inflated price.