What It Is:
Going public refers to a company's first issuance of stock on the open market. In most cases, the offering, called an initial public offering (IPO), makes the company's stock accessible to a large group of public investors for the first time.
How It Works/Example:
The process of going public often begins when a young company needs additional capital to grow its business. In order to gain access to that capital, the firm will sometimes choose to sell an ownership stake -- or shares of stock -- to outside investors.
In order to sell its shares to the public, a company first needs to retain the services of an investment banker to underwrite the issue. The role of the underwriter is to raise capital for the issuing company. The underwriter accomplishes this by purchasing shares from the issuing corporation at a predetermined price, then reselling them to the public for a profit.
In most cases, a single investment-banking firm takes the lead role in setting up a new IPO. This lead firm, referred to as the managing underwriter, then often forms a larger group of investment bankers, called an underwriting syndicate, to participate in the sale. This syndicate in turn often gathers an even larger group of broker dealers to assist with the distribution of the new issue.
The Securities Act of 1933 regulates new issues of corporate securities sold to the public. This law requires that the company file a registration statement and preliminary prospectus with the Securities and Exchange Commission (SEC). The purpose is to ensure that investors are fully informed about the offering and the issuing company.
The issuing company must file a registration statement before going public. It discloses all material information about the company to the SEC. Part of the registration statement is the prospectus, which must be provided to all purchasers of the new issue. The prospectus contains much of the same information included in the registration statement, but without all of the smaller details and supporting documentation.
After the issuer files the registration statement with the SEC for review, the cooling off period begins. During this 20-day period, securities brokers can discuss the new issue with clients, but the only information about the offering that can be distributed is the preliminary prospectus.
The Preliminary Prospectus
The preliminary prospectus declares that the registration statement has been filed with the SEC but is not yet effective. This document contains the same information that will be found in the final prospectus with the exception of the offering price, commissions, the underwriting spread, dealer discounts, and other related financial information. The preliminary prospectus is also known as a red herring because the legend on the cover is printed in red ink.
Indications of Interest
An indication of interest is an investor's declaration that they may be interested in purchasing shares of the IPO from the underwriter after the security comes out of registration. These declarations, however, are not legally binding because sales are prohibited until after the registration becomes effective. The underwriters and the selling group members use the preliminary prospectus to gauge investor receptivity and gather indications of interest.
The Final Prospectus
When the registration statement becomes effective, the issuing company amends the preliminary prospectus to add such important information as the offering price and the underwriting spread. When the final prospectus is released, brokers can take orders to buy from those clients who indicated an interest during the cooling off period. A copy of the final prospectus must precede or accompany all sales confirmations.
The SEC Review
The Securities and Exchange Commission (SEC) reviews each prospectus to ensure that it contains all necessary material facts, but it does not guarantee the accuracy of the disclosures. The agency does not approve the issue, but simply clears it for distribution. The SEC cannot prevent an IPO based on the quality of the offering, but it can require the issuer to disclose all material facts about the offering and the company.
Why It Matters:
Going public is a great way for many companies to raise capital. Though a bank loan might be an option, it requires monthly principal and interest payments that companies -- especially growing, cash-strapped ones -- may not consider wise uses of cash. Going public solves this problem in a way, because shareholders don't require monthly cash payments -- or any payments, for that matter, unless the company is sold.
However, going public does come with a huge set of responsibilities, including fiduciary duties, special governance considerations, and a host of disclosure requirements that can be time-consuming and expensive. Going public also means adapting to analyst coverage, media coverage, and pressure to address both short-term and long-term trends in the share price.