Why do companies go public?

The main reason is money: selling new shares raises cash for growth or for paying down debt. An IPO also gives early investors and employees a way to sell later, lets the company pay staff and buy other businesses with listed stock, and raises its profile.

The price is permanent scrutiny: audited annual reports, quarterly results (see how to read earnings reports), disclosure of major events and public shareholders to answer to. Underwriting and legal costs are high too, one reason some companies stay private longer.

How does an IPO work, step by step?

The drawing at the top of the page shows the usual US path. It typically takes months, and the company can postpone or cancel at any step before pricing.

  1. Hire underwriters. Investment banks advise on the deal and sell the shares; in a typical US IPO they buy them from the company and resell them to investors.
  2. File the S-1. This registration statement, filed with the SEC, contains the prospectus: business, financial statements, risk factors and use of the money. The SEC reviews the disclosure; it does not judge whether the stock is a good investment.
  3. Roadshow. Management presents to institutional investors while the underwriters collect orders within a price range shown in the preliminary prospectus.
  4. Pricing. The evening before trading, the final IPO price is set and the shares are allocated, mostly to institutions and the banks’ clients.
  5. First trade. The next day the exchange matches the orders that have built up, and the stock opens at the price that clears them, often well after the 9:30 a.m. ET open.
  6. Lock-up ends. Insiders who agreed not to sell for a set period become free to sell.
Underwriter
An investment bank that manages an IPO, sets the price with the company and sells the shares.
Prospectus
The disclosure document inside the S-1. Its risk factors section is the place to start.
Float
The shares that can actually trade. Right after an IPO it is often a small part of all shares outstanding.

IPO price vs opening price: why are they different?

The IPO price is what investors who received an allocation pay the company. The opening price is the first trade on the exchange, set by public supply and demand. Unless your broker gives you an allocation, the opening trade is the earliest price you can get.

Hypothetical, as in the drawing below: shares are priced at $20, and heavy demand opens the stock at $27, 35% higher. It swings between about $23 and $31 and closes at $25. Investors who got shares at $20 are up 25%; anyone who bought the opening trade at $27 is down about 7%, on the same stock and the same day. With 100 million shares, $20 a share values the company at $2 billion (its market cap).

The opposite happens too: a stock can open or close below its IPO price. A first-day jump says something about demand for a limited number of shares, not about the business or where the price goes next.

Turn your phone sideways to read the drawing. Tap to close.

A hand-drawn first trading day: a dashed line at the $20 IPO price, labeled paid by allocated investors, and a dotted line at the $27 opening price, labeled what most buyers pay, with a green double arrow between them marked +35%. Ten intraday candles swing between about $23 and $31 and close near $25; a note reads day one: wide swings.

What is an IPO lock-up period?

A lock-up is an agreement in which founders, employees and early investors promise not to sell their shares for a set time after the IPO. Terms vary and are disclosed in the prospectus, but most lock-ups last 180 days, according to the SEC’s investor education site.

Many IPOs sell only a small part of the company. In the hypothetical drawing below, 15 million of 100 million shares are sold in the IPO; the other 85 million are locked up until day 180. Then insiders may sell, but they do not have to. The price sometimes weakens before that date, as traders expect more shares for sale.

Turn your phone sideways to read the drawing. Tap to close.

A hand-drawn stacked bar of all shares: a green base of 15M sold in the IPO that trade from day 1, and a hatched block of 85M with a padlock, held by insiders and early investors and locked up. To the right, a step chart of shares that may be sold: flat at 15M from day 0 to day 180, then a dashed jump to 100M with the note lock-up ends: more shares may be sold.

Direct listings and SPACs: two other ways to go public

In a direct listing, a company lists its existing shares without a traditional underwritten offering. No bank sets an IPO price: the first price comes from the buy and sell orders at the exchange’s opening, and existing holders are often free to sell from day one. Most direct listings have raised no new money, although exchange rules now also allow direct listings that sell new shares.

A SPAC (special purpose acquisition company) is a shell company with no business of its own. It goes public first, keeps the cash it raised in a trust, and has a set deadline, often around two years, to merge with a private company, which becomes listed through that merger. Before the merger, SPAC shareholders can usually redeem their shares for their part of the trust; if no deal happens in time, the money is returned.

Turn your phone sideways to read the drawing. Tap to close.

Three hand-drawn lanes ending in one box, shares trade on an exchange (NYSE, Nasdaq): IPO (banks set the IPO price, then new shares raise cash), direct listing (no IPO price set by banks, then existing shares start trading) and SPAC (a cash shell lists first, then it merges with a private company).

Should you buy an IPO on the first day? The risks

Buying on day one means paying a price set by eager buyers for a stock with no trading history, so many investors wait for the first earnings report. If you do buy, read the risk factors, decide your exit first and size the position so a large drop costs only a small, fixed share of your account (see risk management and how to buy US stocks).

The main risks of buying on the first day:

  • Volatility: a $20 stock can swing several dollars in minutes, and a market order at the open can fill far from the price you saw; a limit order caps your price (see order types).
  • No history: no price chart, no support or resistance, and no earnings report as a public company yet, only the figures in the prospectus.
  • A thin float: with few shares trading, modest orders can move the price a lot.
  • Lock-up expiry: more shares may come up for sale months later.
  • Hype: attention peaks around the listing, and attention is not value.