How Companies Go Public - The IPO Process
An initial public offering is the process through which a private company sells shares to the public for the first time, becoming a publicly traded company on a stock exchange. The IPO is one of the defining events in a company's life: it provides access to public capital markets, creates liquidity for early investors and employees, establishes a market price for the company's equity, and imposes the disclosure and governance requirements of public company status. The U.S. IPO market is the largest in the world, with hundreds of companies going public annually and raising tens of billions of dollars in the process.
Why Companies Go Public
The decision to IPO is driven by several motivations, which vary by company and circumstance.
Raising capital. The most straightforward reason. Public markets provide access to a large pool of capital at relatively low cost. A company that needs billions to fund expansion, research, or acquisitions can raise that capital through an IPO more efficiently than through private funding rounds.
Providing liquidity. Early investors (venture capital firms, private equity funds, angel investors) and employees holding stock options or restricted stock need a mechanism to convert their shares into cash. An IPO creates a public market where these shares can eventually be sold.
Currency for acquisitions. A publicly traded stock can be used as consideration in mergers and acquisitions. Instead of paying cash for an acquisition target, the public company can offer its stock, which is liquid and has a market-determined value.
Prestige and visibility. Being publicly listed on the NYSE or Nasdaq provides credibility, media attention, and brand recognition that can benefit the company's commercial relationships and recruiting efforts.
Valuation benchmark. A public stock price provides a continuous, market-based valuation of the company, which is useful for executive compensation (stock-based pay), strategic planning, and stakeholder communication.
The IPO Timeline
The IPO process typically takes 4 to 6 months from the initial decision to the first day of trading.
Selecting underwriters (months before filing). The company selects one or more investment banks to serve as underwriters. The lead underwriter (or "bookrunner") manages the process, advises on pricing and timing, and coordinates the syndicate of other banks involved in selling shares. For large IPOs, multiple banks share the bookrunner role.
The selection process involves "bake-offs," where investment banks pitch their qualifications, market knowledge, distribution capabilities, and proposed valuation range. Goldman Sachs, Morgan Stanley, and JPMorgan are the most frequent lead underwriters for large U.S. IPOs. For smaller or specialized companies, banks like Jefferies, Piper Sandler, or technology-focused firms may lead.
The underwriting fee is typically 5% to 7% of the total IPO proceeds, known as the "gross spread." On a $1 billion IPO, the banks earn $50 to $70 million.
SEC filing (S-1 registration statement). The company files a registration statement (Form S-1) with the Securities and Exchange Commission. The S-1 contains comprehensive disclosures about the company's business, financial statements (audited by an independent accounting firm), risk factors, management team, ownership structure, and the terms of the offering.
The SEC reviews the S-1 and issues comments, requesting clarification or additional disclosure on specific points. The company and its lawyers respond to these comments, and the process typically involves two to three rounds of back-and-forth over several weeks. The SEC does not approve or disapprove the offering; it declares the registration statement "effective" when the disclosure requirements are satisfied.
Marketing and roadshow (2-3 weeks). Once the S-1 is filed, the company's management and the lead underwriters embark on a "roadshow," a series of presentations to institutional investors across major financial centers. The roadshow typically lasts 10 to 14 business days and covers cities including New York, Boston, San Francisco, Los Angeles, Chicago, and London.
During the roadshow, management presents the company's business strategy, competitive advantages, financial performance, and growth prospects. Institutional investors ask questions and indicate their interest in purchasing shares. This feedback helps the underwriters gauge demand and refine the pricing range.
Book building. Based on the roadshow feedback, the underwriters build a "book" of orders from institutional investors. Each investor specifies the number of shares they want and the price they are willing to pay. The book reveals the demand curve: how many shares can be sold at each price level.
Pricing. On the evening before the first day of trading, the company and the lead underwriter agree on the final IPO price. This price reflects the demand observed during book building, the company's valuation preferences, market conditions, and the underwriter's judgment about where the stock should trade on day one.
The pricing decision involves a fundamental tension. The company wants the highest possible price (maximizing capital raised). The underwriter wants a price that leaves room for first-day appreciation (happy institutional clients who received allocations will do more business with the bank in the future). This tension produces the well-documented pattern of IPO underpricing.
Allocation. The underwriter allocates shares to institutional investors based on their order size, long-term investment orientation, relationship with the bank, and other factors. Large mutual funds, pension funds, and hedge funds receive the biggest allocations. Retail investors typically receive little or no allocation in popular IPOs.
First day of trading. On the morning of the first trading day, the stock opens for trading on its designated exchange. The opening price is determined by an auction process (the designated market maker on the NYSE or the opening cross on Nasdaq) that matches accumulated buy and sell orders.
IPO Underpricing
One of the most studied phenomena in finance is IPO underpricing: the tendency for IPO stocks to trade significantly above their offering price on the first day of trading.
Historical data shows that the average first-day return for U.S. IPOs is approximately 15% to 20%. In hot markets, the average can be much higher. During the dot-com bubble of 1999-2000, the average first-day return exceeded 65%. During 2020-2021, many IPOs doubled or tripled on their first day.
Underpricing represents money that the issuing company "leaves on the table." If a company prices its IPO at $20 per share and the stock opens at $25, the company received $5 less per share than investors were willing to pay. On a 50-million-share offering, that is $250 million in capital the company did not capture.
Why does underpricing persist? Several theories:
Winner's curse. Uninformed investors who receive IPO allocations disproportionately receive shares of less desirable IPOs (because informed investors crowd into the best ones). To compensate uninformed investors for this adverse selection, IPOs must be priced at a discount on average.
Underwriter incentives. Investment banks benefit from underpricing because it makes their institutional clients happy (they receive profitable allocations) and generates trading commissions on first-day volume.
Signaling. Companies may accept some underpricing as a signal of quality. A stock that trades up 15% on day one generates positive media coverage and investor enthusiasm that can benefit the company in future capital raises.
Direct Listings
As an alternative to the traditional IPO, some companies have chosen to go public through direct listings. In a direct listing, the company does not issue new shares or raise new capital. Instead, existing shareholders (insiders, employees, early investors) sell their shares directly on the exchange.
Spotify pioneered the modern direct listing in 2018. Palantir, Coinbase, and Roblox followed. The advantages include no underwriting fees, no lockup agreements (insiders can sell from day one), and no underpricing (the opening price is set by the market auction, not by an underwriter).
The disadvantages: the company raises no new capital (though the SEC later allowed capital-raising direct listings), there is no guarantee of an orderly first-day trading experience, and there is no underwriter to support the stock price through stabilization purchases.
Direct listings work best for well-known companies with strong brand recognition that do not need to raise capital and whose investors want immediate liquidity. They are not practical for lesser-known companies that need an underwriter's distribution network and marketing support.
The Lock-Up Period
Most traditional IPOs include a lock-up agreement that prevents insiders (executives, employees, venture capital investors) from selling their shares for a specified period, typically 90 to 180 days after the IPO. The lock-up is designed to prevent a flood of insider selling immediately after the IPO, which could depress the stock price.
Lock-up expirations are closely watched by traders. When a large volume of previously locked-up shares becomes available for sale, the stock often experiences selling pressure. The anticipation of lock-up expiration can itself drive price declines in the weeks leading up to the date.
Not all lock-ups are the same. Some release all shares on a single date. Others release shares in tranches over several months. Some have early release provisions triggered by the stock trading above a specified price for a certain number of days.
IPO Performance: The Long-Term Record
While the average first-day return is positive, the longer-term performance of IPO stocks is a different story.
Research by Jay Ritter at the University of Florida, the leading academic authority on IPO performance, shows that IPOs underperform the market over three-to-five-year holding periods following the first day of trading. The average IPO purchased at the first-day closing price underperforms a benchmark of comparable stocks by roughly 20% over three years.
The underperformance is concentrated in smaller, younger companies. Large-company IPOs with established businesses and positive earnings tend to perform reasonably well. Small, pre-revenue companies with speculative growth stories account for the bulk of long-term underperformance.
The pattern suggests that investors who buy IPOs at inflated first-day prices, driven by hype and limited share supply, pay too much relative to the company's subsequent fundamental performance. The initial enthusiasm fades as the company reports actual results, more shares enter circulation (through lock-up expiration and secondary offerings), and the stock converges toward a valuation supported by fundamentals rather than novelty.
The IPO Cycle
IPO volume is cyclical, closely linked to stock market performance and investor sentiment.
Hot IPO markets (2020-2021, 1999-2000) feature high volumes of offerings, aggressive valuations, strong first-day returns, and sometimes pre-revenue companies going public. Hot markets create a self-reinforcing cycle: successful IPOs attract more companies to go public, which attract more investor interest.
Cold IPO markets (2022, 2008-2009) feature minimal IPO activity as falling stock prices reduce valuations, investor appetite for risk declines, and companies delay their public debuts. The 2022 IPO market was the weakest since 2009, as rising interest rates and falling equity valuations made the IPO window unattractive for most companies.
The IPO market reopened gradually in 2023 and 2024, with Arm Holdings, Instacart, and Birkenstock among the notable offerings. The recovery was selective, with investors demanding more reasonable valuations and stronger fundamentals than during the 2020-2021 boom.
For investors, the IPO market cycle provides a useful signal about broader market sentiment. A flood of IPOs suggests that corporate insiders and their advisors believe valuations are high enough to sell equity to the public, which has historically been a contrarian indicator of market conditions.
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