In this video we're going to talk about IPO's and what it means when a company goes public.
IPO stands for Initial Public Offering.
In other words, this is the first time a company's stock is available for the general public
to buy on a stock exchange.
Instead of IPO you may sometimes just hear that a company is going public.
So what does that mean?
To understand this in the context of what we're talking about, a company can either
be private or public.
What determines that?
Let's bring this into a scenario where you are the company owner and you have a company
called Snowcone that sells well...snow cones.
You probably started your snow cone company alone, you likely took your own money to buy
the actual stands and any other supplies you needed to get this business up and running.
Your company is doing well, you open up stands across your city, and even a few brick and
mortar locations.
But you get to the point where your snow cone stands are basically the new Starbucks of
your city, everyone goes there.
But, you want to expand even further outside of your own city.
However you don't have the funds to do so.
So what you would need to do is to actually start raising money for your company.
The first place you might start is by asking friends or family or people that you work
with.
Maybe you even know some random outside people or investors who want to be involved, or maybe
you even take your business and go on Shark Tank.
You may have heard terms before like seed or angel investing, venture capitalists, and
private equity firms.
This is where those groups of people potentially come in.
These are very simply just groups of people who want to be early investors in your company.
Typically what would happen is that they would give you money, and in exchange for that you
would give them part equity or ownership in the company.
Again, going back to Shark Tank, that's exactly what we see on there.
We would consider these people private investors.
They want to put their own money into your company because they want to see it grow and
they eventually want to be able to make a return on their money if your company does
really well, makes a lot of revenue, and increases in value.
That increases the value of their shares as well and the equity that they have in your
company.
It's beneficial to them to get in as early as they can so that they can see the maximum
amount of return.
This is how a lot of big businesses start out.
But even at this point, your company Snowcone is still considered private.
Even though you may have some random outside investors helping you out, these are individual
people or individual firms that are coming to you directly.
So we still consider these people as private investors.
So at this point, it is just you and those private investors.
Your neighbor can't go on Yahoo Finance and look up Snowcone's stock price because it
isn't there.
Likewise, you can't go and just randomly list your company on the NYSE because that's not
how it works - you're a private company.
But if your company is growing fast enough, you may need to raise more money than what
these private investors can give you in order for you to be able to expand and to keep growing
the business.
This is where an IPO comes in.
By making your company available for the public to invest in, this allows you the potential
to raise a lot of money.
And when you choose to do that and you choose to start the IPO process, this is when we
say a company is "going public".
So in order to get Snowcone to the point where it is listed on the NYSE where you or your
neighbor can go and look it up on Robinhood, that is where we have to go through the IPO
process or an initial public offering.
This usually starts with an investment bank and there are a few things the investment
bank is going to determine.
They're going to make sure you're legitimate, they're going to check financial statements,
assets, things like that for your company, they're going to check up on your management,
and they are going to give your company a valuation.
In other words, how much they think your company is actually worth.
Then, you're going to determine how much of your company you are going to make available
to the public to buy.
In other words, this is how much of the company you are actually giving up ownership of.
So maybe you come to the agreement that you are going to give up 30% of the company which
let's say is worth $1,000,000.
The next step is to determine how many shares make up that $1,000,000, and that will determine
what price those shares are actually at.
So for example, if you split that $1,000,000 into 100,000 shares, that means that you would
have 100,000 shares available at $10/piece.
So the investment bank will then essentially buy those 100,000 shares from you at a set
price.
This whole process is called underwriting.
But in addition to the things that we just talked about, it's also the investment bank's
job to get your company filed with the SEC, get you listed on a stock exchange, and to
actually distribute those shares that they bought from you.
This usually requires a roadshow or essentially going around and pitching or promoting your
company to different groups of investors.
So basically they're going to help you market your stock and generate interest in it from
different firms, brokerages, investors, etc.
This is the point before an IPO happens when you hear a lot of hype about the company.
Now the companies themselves are actually usually limited on what they can share with
the general public during this whole process.
But there is a lot of speculation that goes on during this time, so you may still hear
a lot about this company and their process of going public.
Now during this process before it's actually available to the general public, the investment
bank is going to be sharing this around with different institutions and investors.
These institutions and investors are able to submit an IOI or and indication of interest.
This isn't a binding contract or anything.
It's essentially them just saying "hey yeah I'd buy that".
A normal person like you or me usually cannot get access to a company that is going through
the IPO process that early on.
We have to wait even longer until it's actually listed on the stock exchange and available
for retail investors or people like you and me to buy through TD Ameritrade or Fidelity
or Robinhood, or any of your normal brokerages.
This is one of the reasons why IPOs can sometimes be considered risky.
Many times by the time the stock actually is available for the general public to buy,
there's a good chance that it might be overpriced.
And in The Intelligent Investor which is a famous book, they have famously said that
IPO really stands for "It's Probably Overpriced".
And of course this isn't always the case, but it is the investment bank's goal to sell
those shares for more than they bought it from the company for.
So in this case with your company Snowcone, when that investment bank bought those shares
from you for $1,000,000 when they turn around and they are selling those shares to the investors
and to the public, they want those shares to be valued at more than $1,000,000 that
way they are able to make money off of it as well.
They obviously want to make money, the company obviously wants to make money, so that's something
just to stay aware of.
When a company first goes public there is a chance that that stock price is going to
be overpriced.
A lot of that stock's initial movement can be based on hype and speculation rather than
the fundamentals and performance of the company.
Also keep in mind that a company chooses when they go public.
So they obviously going to choose the time that they think is best when they can get
the most money for it.
Going public during the middle of a recession or depression - probably not a good idea.
Going public now when the stock market is going up and it looks like it's never going
to stop - yeah that seems like a pretty good time to try to go public.
So with IPOs, what actually happens when a company does go public?
Well you may see some of the company's owners and employees selling their shares to cash
out, and you may see the same with some of those early investors.
People either do this to cash out a little bit, take some of their money, make a little
bit of a profit, or they may be exiting the company completely.
If you had gone on Shark Tank with your company and Mark Cuban became an investor in your
company Snowcone, at this point after the company has gone public, he may decide that
he's been helping you out for a while, but it's time for him to not be involved anymore,
so he wants out completely.
When you go public, he may decide that he wants to take his profits, he's going to sell
all of his shares, and leave the company.
In actuality the process is a bit more complicated than that, but that's the basics of it.
If you are employed at a startup and as part of your compensation they give you shares
of their private company, if that company ever goes public, that could be a fantastic
payday for you.
So think of people who started working at Amazon or Tesla really early on and got some
shares of the company as they stayed in the company longer and that was just part of their
pay.
Well now, those shares are probably worth a lot more than they were when they just started
at the company.
This is also why a lot of high net worth individuals choose to get into angel investing.
They want to be in some of those first rounds of investors that put money into these companies
that way they have the maximum potential to actually make a profit if these companies
ever choose to go public in the future.
What actually happens to the price of stocks when a company goes public?
Well it's hard to say.
Some see a very steep increase in price and an equally steep decline, some level off,
some don't see very volatile movement at all, and some just decline forever.
It's really just depends on the company, there's no one-fits-all situation.
So you really do have to know the background of that specific company.
But what's getting interesting about the IPO space is that there are now ways for companies
to actually get around going through this traditional IPO process.
They do this through something called a SPAC.
If you want to learn what a SPAC is and how it works, click on this video where I explain
why SPACs are becoming so popular, and how companies are avoiding the traditional IPO
process.
I'll see you guys over there.