Page 24 - Initial Public Offering - An Introduction to IPO on Wall Street

2. Introduction to IPO

Before a company goes public through an IPO, it has a limited number of shareholders and thus
the capital available to it is also limited.

No matter how much money you have available to pump into your business through personal
investments, strategic partnerships, angel investors, or venture capitalists, it can never match
up to what you would have by going public.

When you go public with your company, you expand your pool of potential investors and are
ultimately able to raise more capital than before. Let me explain this using a real-life example.

Our childhood is probably is the most interesting period in our lives. Not only is it a time when
we have the most fun, but it is also a time when we love to experiment.

While the amount of experimentation someone did during their childhood would vary from
person to person, certain experiments were done by all of us. One of them was experimenting
with a waterspout.

If you recall your childhood days, playing in the garden with a waterspout would probably be
one of the first memories to come to mind. Do you remember what happened when you pressed
your thumb against the waterspout? You felt pressure beneath your fingers, right?
And what happened when you let loose? The water splashed out all at once upon release and
reached a greater elevation than it would have if you simply opened water and let it flow out.

What do you think made the difference in the first case? It was the pressure applied.

Within a waterspout, water collects at the same place and all of it is released at the same time.
If no pressure is applied to the water, it will simply flow out without any particular direction or
energy.
The same is applicable to the securities market where offer and demand are fluxes that can be
compared to water flows. Both offer and demand fluxes are dealt with by an Initial Public
Offering (IPO) within the same instant.

To understand what makes an IPO so valuable, you need to know its alternatives and what they
accomplish.

The first alternative to an IPO is a merger. While it is a good way for a private company to
increase its stock price, a merger will only go through if the private company adds to the
revenue, profit, or valuation of the publicly limited company it is merging with.

On the other hand, a reverse merger—the other alternative to an IPO—is an easy route to
becoming a public company but it will rarely, if ever, result in an increased stock price of the
company. This is because many of the problems and challenges that caused the public company
being bought to become a shell—a company that exists only on paper and has no active offices,
employees, bank accounts, assets, or passive investment holdings—will remain. In other words,
there will never be enough market making to reach even a fraction of the performance of an
IPO.

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