What Is an IPO? How Companies Go Public

Private companies IPO for three reasons, in roughly this order of honesty:

Capital. Going public raises cash. A company selling 10% of its shares at a $50 billion valuation pockets $5 billion to fund growth, acquisitions, or debt repayment. Arm Holdings raised $4.87 billion in its September 2023 IPO — the largest tech listing in two years.

Liquidity. Early employees, venture capitalists, and founders hold shares they can't easily sell while the company is private. An IPO creates a public market where those insiders can eventually cash out, typically after a 90-180 day lock-up period expires.

Currency. Public shares become acquisition currency. A company with publicly traded stock can buy other companies using shares instead of cash, which is why many tech firms go public shortly before an acquisition spree.

There's a fourth reason nobody puts in the press release: the valuation window. When markets are hot and multiples are stretched, the incentive to IPO is strongest. Reddit priced its IPO in March 2024 at $34 per share. The stock trades at $143 today — a win for early shareholders, though it has pulled back from a peak near $283.

An IPO typically takes 4-6 months from the decision to go public to the first day of trading. Here's the sequence:

1. Hire underwriters. The company selects investment banks (Goldman Sachs, Morgan Stanley, JP Morgan are the usual suspects) to manage the offering. The lead underwriter structures the deal, prices the shares, and distributes them to institutional investors. Banks earn a 3-7% commission on the total proceeds.

2. File the S-1. The company files a registration statement (S-1) with the SEC. This document discloses financials, risks, management backgrounds, and how the proceeds will be used. The S-1 is public — anyone can read it on the SEC's EDGAR database. Read it. Most investors don't, which is why they're surprised when a newly public company reveals risks that were in plain print all along.

3. The roadshow. Management tours institutional investors — pension funds, hedge funds, mutual funds — pitching the company's story. This is where demand gets gauged and the price range narrows. Retail investors are not part of this process.

4. Pricing. The night before trading begins, the underwriter sets the final IPO price based on institutional demand. This is where the inherent conflict lives: banks want a low enough price to guarantee a first-day pop (keeping their institutional clients happy) but a high enough price to maximise the company's capital raise.

5. Trading begins. Shares open on the exchange. The opening price is often significantly higher than the IPO price because institutional investors who received allocations at the IPO price are sitting on instant paper gains, creating buying pressure from retail investors who want in.

The traditional IPO isn't the only path to public markets anymore.

Direct listings skip the underwriter and the IPO price entirely. The company simply lists its existing shares on an exchange and lets the market determine the price from the opening auction. Spotify and Coinbase used this approach. No new shares are issued, no capital is raised, and no lock-up period applies — existing shareholders can sell immediately. The advantage: no underwriter fees (saving 3-7%) and no first-day pop benefiting banks' clients at the company's expense.

SPACs (Special Purpose Acquisition Companies) were the hot alternative from 2020-2021. A blank-check company raises money through its own IPO, then merges with a private company to take it public. SPACs allowed companies to go public faster and with forward-looking financial projections that traditional IPOs don't permit. The track record has been abysmal — the IPOX SPAC Index has underperformed the S&P 500 by over 50 percentage points since the 2021 peak. Most SPACs from that era trade below their $10 initial price.

For most large, profitable companies, the traditional IPO remains the default. But the rise of alternatives has pressured banks to reduce their fees and give companies more pricing power.

If you're considering buying a stock within its first year of trading, here's a practical checklist:

Read the S-1. Every risk factor, every related-party transaction, every use-of-proceeds disclosure is in this document. Pay special attention to the "Risk Factors" section and the insider ownership tables.

Wait for the lock-up expiry. When the 90-180 day lock-up ends, insiders can sell. This creates a supply surge that often pushes the stock price down 5-15%. There's no rush. If the company is genuinely good, it will still be good six months from now.

Check profitability. Many companies go public while still losing money. Snowflake's trailing EPS is -$3.95. Arm Holdings earned just $0.75 per share at a $127 stock price — a P/E of 169x. Reddit earned $2.62 per share at $143 — a P/E of 55x. High multiples are expected for fast growers, but you need to understand what growth rate justifies the valuation.

Watch insider selling after lock-up. If executives and board members start selling aggressively once they're allowed to, that's a signal worth heeding. They have more information about the business than you do.

Ignore the first-day price. It reflects hype, scarcity, and institutional game theory — not fundamental value. The best entry points for IPO stocks are usually 3-12 months after the listing, once the dust settles and the company has reported at least one or two quarters of public earnings.