Initial Public Offerings, or IPOs, are sold when a company that was previously private offers shares to be publicly traded on a stock exchange. This process is well understood by those who trade stocks and work in finance, but the minor detail of pricing is lesser known. There are various factors that are present and which contribute to the purchase price of the new stocks. It is beneficial to research and understand the valuation process of IPOs.
How an IPO Price Is Determined:Stage One
There are two main questions that must be decided before a company decides to go public. Firstly, the owners must decide how much control they are willing to offer for sale. Secondly, they must determine how much they are willing to sell control of their company for. Accounting and financial numbers are looked over, and this information is then sent to an underwriting bank.
Percentage of Control
Businesses with few owners will have a much simpler time determining how much control they are willing to sell when compared to businesses with many owners and investors. This is because it is not difficult to determine who, at the end of the IPO process, will still have decision making power. When there are numerous stakes in the private business, some people are bound to lose a great deal of control during the transition to public ownership.
As more people put money into the business, it becomes more valuable, but each individual has less shares and therefore less control. This trade off is generally acceptable, though some people may be more interested in holding power rather than making more money. So, after much discussion, the business decides on what percentage of control that they are willing to sell. They then let the bank and other financial institutions know that they intend to release an IPO.
The number of shares may increase if there is positive reception regarding the sale of the IPO. If there is little support or interest, then the business may rescind their offer. This feedback will help the business make another determination regarding the price of each individual share. During this time, there is not yet a defined price per share, and everyone who is thinking about the IPO is working on determining the potential purchase price of the shares.
Price of Shares
In response to the feedback of the banks, financial institutions, investors, owners and advisers, the business will work out a few price schemes. They may play with a variety of prices, each designed either to maximize income or to secure control over their business. Businesses may be interested in releasing their IPO when the stock market will offer them the best price. Essentially, the better the stock market is doing at the time of release, the higher price the IPO will sell for.
Ad campaigns, business deals and all kinds of financial information will be shared at this time. It is beneficial to the company to have as many people vying over the price of the IPO as possible. Releasing an IPO is risky, and many businesses have no received the financial inputs needed to offset the loss of control. This is one of the most important times in the life of any business.
At this time, it is easier for large money managers to discuss terms of IPO pricing. Small investors do not have the financial capacity to influence the initial price as much as hedge funds and large banks. During this time, complicated financial discussions are held between the business and numerous financial institutions. In time, these discussions, offers and bids are taken into account and a final IPO price is determined.
Find out the next steps in how an IPO price is determined by reading more on the next page.