Key takeaways

• IPOs typically involve SEC filings, underwriters, pricing, and an exchange listing
• Existing shareholders may gain a path to liquidity, subject to restrictions
• Retail investors may not receive shares at the original IPO offering price

Initial public offerings (IPOs) often make headlines when a well-known company decides to go public. But it helps to understand the basics behind the buzz: What is an IPO, and what does going public mean for companies and investors?

An IPO is more than a stock-market debut. It can help a company raise capital and give public investors access to its shares — but it also comes with new requirements for the company and risks for the investor.¹  

Here's how IPOs work, why companies pursue them, and other essentials to know.

What is an IPO?

An IPO is the first time a private company offers shares of its stock to the public. In conjunction with an IPO, a company usually applies to list its shares on an established stock exchange, such as the New York Stock Exchange or Nasdaq.² 

Before going public, a company's shares aren't broadly traded on a public exchange. Private company ownership may include founders, employees, venture capital firms, and other private investors. An IPO changes that by transitioning the business into a public company.³ 

How does an IPO work?

The IPO process involves several steps a private company takes to become publicly traded. Each offering is different, but companies must follow a basic path of preparing financial disclosures, filing registration documents with the Securities and Exchange Commission (SEC), setting an offering price, and listing shares on a public stock exchange.⁴

During the process, the company files a registration statement with the SEC, typically using Form S-1. An important part of the registration statement is the prospectus, which provides information about the company's business, financial condition, management, risks, and the terms of the offering.⁵

Here's how an IPO works at a general level:⁶

Companies go through an IPO for a variety of reasons, but two common ones are to raise capital and provide potential liquidity for existing shareholders.⁷

By issuing shares to the public, a company can raise money to fund growth, expand operations, invest in new products or technology, hire employees, repay debt, or pursue acquisitions.⁸

An IPO can also create a path for company founders, employees, and early investors to sell some of their shares, although lockup periods and other restrictions may limit when they can sell. The terms of lockup agreements vary, but they can often prevent insiders from selling their shares for 180 days. Lockups also may limit the number of shares that can be sold over a designated period of time.⁹

There are other reasons why companies go public, such as to increase a company's visibility and establish a market price for its shares.¹⁰

Going public does have tradeoffs. In addition to SEC reporting and disclosures, public companies face stock-exchange requirements and greater scrutiny from investors, analysts, regulators, and the media. 

What IPOs mean for individual investors

Many investors first encounter IPOs through news coverage of well-known companies going public. In practice, there are two common ways to invest.

The underwriters and the company that issues the shares control the IPO process and have wide latitude in allocating IPO shares. Some brokerage firms offer eligible clients the opportunity to participate in an IPO before public trading begins. But access isn't guaranteed, and popular offerings often have limited share allocations.¹¹

The second, and more common approach for individual investors, is to wait until shares begin trading on a public exchange and buy them through a brokerage account, just as they would other publicly traded stocks.¹²

Benefits and risks of IPO investing

An IPO can give investors the opportunity to buy shares of a company as it starts a new phase as a public business. At the same time, newly public companies often have a limited trading history and can be risky and speculative investments, according to the SEC.¹³ 

Here are some of the potential opportunities and risks to consider:¹⁴ 

IPOs vs. direct listings, SPACs, and secondary offerings

An IPO is one way a private company can enter the public market, but it isn't the only path. Companies can also become publicly traded through direct listings or transactions involving special purpose acquisition companies (SPACs).¹⁵

Each of these transactions have different structures and purposes:¹⁶

IPO: A private company raises capital by selling newly issued shares as it goes public.

Direct listing: A private company becomes publicly traded, typically without raising new capital, by allowing existing shareholders to sell their shares directly to the public.

SPAC transaction: A special purpose acquisition company, or SPAC, goes public as a shell company and later combines with a private operating company, resulting in the operating company becoming public.

IPOs as part of investment plans

An IPO is an opportunity to invest in an individual company, not a complete investment strategy. Even if a new public company looks promising, consider how owning its stock would fit with your broader financial goals, investing time horizon and risk tolerance.

Also consider whether you understand the company's business and risks. Diversification across different investments can help reduce the risks that come with relying too heavily on a single company, though it doesn't guarantee gains or protect against losses.

It can also help to consider an IPO alongside the rest of your financial picture. Investing basics include looking at priorities such as emergency savings, debt, and long-term goals such as retirement when deciding how investing fits into your financial plan. Investors who want to buy individual stocks generally can do so through a brokerage account.

Research is important too: An interesting company isn't necessarily an appropriate investment for every portfolio. Consulting a financial professional can also help investors consider how an individual stock fits into their broader financial plan.

Frequently Asked Questions about IPOs

How long does an IPO take?

The IPO timeline varies depending on the company's preparation, market conditions, and regulatory review. The public-facing process often takes several months or longer, while companies may spend much longer preparing before filing.¹⁷

What is an IPO roadshow?

An IPO roadshow is a series of presentations in which company executives and underwriters meet with prospective investors before the offering is priced. Roadshows are generally aimed at institutional investors rather than everyday retail investors.¹⁸

What happens to employees when a company goes public?

Employees who receive company stock or equity awards may see changes in the value and liquidity of their holdings. When they can sell shares often depends on the company's equity plan, trading policies, and any applicable lockup restrictions.

What is an IPO investment?

An IPO investment generally means buying shares of a company around the time it becomes publicly traded. Some eligible investors may receive shares at the offering price through a brokerage, while others purchase shares after trading begins on a public exchange.