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    Mutual Funds And Initial Public Offerings

    An initial public offering (IPO) refers to the process of offering shares of a private corporation to the public in a new stock issuance for the first time. An IPO allows a company to raise equity capital from public investors.

    The transition from a private to a public company can be an important time for private investors to fully realize gains from their investment as it typically includes a share premium for current private investors. Meanwhile, it also allows public investors to participate in the offering.

    KEY TAKEAWAYS

    • An initial public offering (IPO) refers to the process of offering shares of a private corporation to the public in a new stock issuance.
    • Companies must meet requirements by exchanges and the Securities and Exchange Commission (SEC) to hold an IPO.
    • IPOs provide companies with an opportunity to obtain capital by offering shares through the primary market.
    • Companies hire investment banks to market, gauge demand, set the IPO price and date, and more.
    • An IPO can be seen as an exit strategy for the company’s founders and early investors, realizing the full profit from their private investment.

    How an Initial Public Offering (IPO) Works

    Before an IPO, a company is considered private. As a pre-IPO private company, the business has grown with a relatively small number of shareholders including early investors like the founders, family, and friends along with professional investors such as venture capitalists or angel investors.

    An IPO is a big step for a company as it provides the company with access to raising a lot of money. This gives the company a greater ability to grow and expand. The increased transparency and share listing credibility can also be a factor in helping it obtain better terms when seeking borrowed funds as well.

    When a company reaches a stage in its growth process where it believes it is mature enough for the rigors of SEC regulations along with the benefits and responsibilities to public shareholders, it will begin to advertise its interest in going public.

    Typically, this stage of growth will occur when a company has reached a private valuation of approximately $1 billion, also known as unicorn status. However, private companies at various valuations with strong fundamentals and proven profitability potential can also qualify for an IPO, depending on the market competition and their ability to meet listing requirements.

    IPO shares of a company are priced through underwriting due diligence. When a company goes public, the previously owned private share ownership converts to public ownership, and the existing private shareholders’ shares become worth the public trading price. Share underwriting can also include special provisions for private to public share ownership.

    Meanwhile, the public market opens up a huge opportunity for millions of investors to buy shares in the company and contribute capital to a company’s shareholders' equity. The public consists of any individual or institutional investor who is interested in investing in the company.

    Overall, the number of shares the company sells and the price for which shares sell are the generating factors for the company’s new shareholders' equity value. Shareholders' equity still represents shares owned by investors when it is both private and public, but with an IPO, the shareholders' equity increases significantly with cash from the primary issuance.

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