The how, what, and whys of Initial Public Offerings (IPOs)
Everything you need to know about IPOs both as the owner of a company, and as a possible investor By Ariba Shahid
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very time that a company making an Initial Public Offering (IPO) enters into the news cycle, there is some confusion as to what exactly an IPO is and how it works. As the name suggests and one might intuitively guess, an IPO is when a private company decides to go public and offers people the opportunity to buy shares or stocks in it. But to understand the technicalities of this, one must know what stocks are exactly and how they work, as well as the different ways that one can participate in an IPO and the advantages and disadvantages that come with these different ways. Essentially, an IPO happens when a company is looking to gain capital and turns to the general public for it rather than getting a loan from a bank and increasing their debt. It usually means that a company is looking to expand and expand at a certain rate. However, in Pakistan, IPOs are not that common and a lot of family owned companies that have made it big (think Tapal or Shan) want to keep the business limited to themselves and shy away from going public. This is mostly due to the business culture in Pakistan, but if a large privately owned company in Pakistan wanted to raise some serious capital and go on an aggressive expansion project.
What are shares and stocks?
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efore we get into the details of what an IPO is, we need to begin with a very brief understanding of what a private company is, what shares are,
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what stocks are, and how the trade of these entities work. Essentially, any company is owned in shares between numerous people. Stock is all of the shares into which ownership of a corporation is divided. A single share of this overall ‘stock’ represents a fractional ownership of the company. The stock exchange is where you can buy and sell shares in publicly traded companies. As soon as you buy shares of stock on the stock market, you become a shareholder within the company by acquiring an ownership stake of the business. All publicly-traded companies have their equity split up in a great number of shares that are constantly switching owners throughout the day. So one question that you might ask yourself is: How many shares does a company have? The answer to this question depends. Since there is no restriction for the number of shares within a company, different types of companies can have varying numbers of existing shares. A start-up might only have a few shareholders, while multi-billion dollar companies will usually consist of millions or even billions of shares outstanding. Deciding on how many shares a company should start with, depends on the future growth potential of the company. Therefore, the number of shares is completely determined by the business and its owners. This is also where IPOs become important. You see when a company is privately owned, it may issue stock and have shareholders, but their shares do not trade on public exchanges. When these companies do want to go public, they offer shares in their stock through an initial public offering (IPO). Essentially, when a company wants
to bring in capital they decide that they will offer shares at a certain price that the general public can then buy - meaning the number of shares that make up their overall stock increase. And since these new shareholders are bringing in money, the overall size of the stock also increases. The new shareholders will eventually get dividends based on the profits that the company makes. The goal is that the freshly raised capital through the selling of shares will allow the company to grow and thus make greater profits for everyone involved. Generally, a company can choose how many shares it chooses to have. Choosing a number depends on how big you expect your company to get and how much you think it will be worth it - a valuation the company has to make. Take for example an IPO that is made at around $10 per share value. If you estimate your company’s value to be $1 million at the IPO, then the number of authorized stocks should be 100,000. In the beginning, your business won’t be worth $1 million, so each stock won’t be worth $10. Each share may be worth pennies, but over time, its value will hopefully increase. Once you’ve decided on your number, you want to decide how you’re going to issue stocks. A general formula that is at tims recommended is that startups should issue 60 percent of authorized stocks and reserve 40 percent for investing and stock options. The rest belongs to the founders of the company. You can keep more or less of your stocks for founders - that is up to the company. Many businesses have between 5 and 30 percent founder ownership at the company’s IPO.
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