Stocks are the basis of many of our investment initiatives as we strive to make money on the stock market.
Even when we’re slinging shares back and forth, how many of us actually understand what stocks are?
In this article, we dig into why companies use stock, the inner workings of the process, and how you can use this information to be a better investor.
Why Do Companies Issue Stock?
Every business reaches a point where it needs money to grow. Some borrow from banks, while others decide to sell ownership shares to raise funds. When a company chooses to sell a portion of itself to the public, it’s known as issuing stock.
Understanding how companies issue stock is one of the most important lessons for new investors. It explains how businesses grow, how investors get involved, and why the stock market plays such a central role in the economy.
By issuing stock, a company can raise large amounts of capital without taking on debt. That money can be used to expand operations, build new products, or pay off loans. At the same time, investors gain a chance to own part of a business they believe in and benefit from its success.
What Is an Initial Public Offering?
An initial public offering, or IPO, is the first time a private company sells its shares to the public. Before this step, ownership is usually limited to founders, employees, and early investors. The IPO changes that by opening the door for anyone to become a shareholder through the stock market.
The main purpose of an IPO is to raise capital for growth. For example, a fast-growing tech company might need funds to build new facilities or expand into international markets. Selling shares to the public provides that capital and often gives the company greater visibility and credibility.
Think of it as the moment a private company joins the public stage, moving a business from a small circle of owners into a public enterprise where investors everywhere can participate.
How the IPO Process Works
The stock issuance process usually unfolds in several clear steps. It starts when a company’s board decides that going public makes sense for long-term growth. Once that decision is made, the company hires large investment banks known as underwriters.
Underwriters guide the company through the IPO by helping determine its value, advising on how many shares to sell, and setting an initial price range. This process, known as underwriting an IPO, is crucial because it ensures the company raises enough money while offering investors a fair entry point.
Next comes a detailed legal filing with the Securities and Exchange Commission (SEC). This includes a prospectus, a document that outlines the company’s financial results, risks, and business strategy.
Once the SEC reviews and approves the filing, the company’s leaders and underwriters often hold meetings with large investors, known as a roadshow. These meetings build interest and help finalize the offering price.
Finally, on IPO day, the company issues its shares to the public, and trading begins on a stock exchange such as the New York Stock Exchange or Nasdaq. The money raised, minus fees, goes to the company, marking its official entry into the public markets.
Life After Going Public
After the IPO, trading shifts from the primary market, where the company first sold the shares, to the secondary market, where investors buy and sell shares among themselves. The company does not receive money from these trades, but the activity helps establish a market price and provides liquidity, so shareholders can easily turn their stock into cash.
Once public, the company must meet higher reporting standards based on the exchange it’s a part of. It typically has to file routine financial reports, hold shareholder meetings, and announce major business events. These rules ensure that all investors, big or small, have access to the same information.
What Is a Secondary Offering?
After a company has gone public, it might later decide to sell more stock. This is called a secondary offering or a follow-on offering. Understanding what a secondary public offering means is key to seeing how companies continue to raise funds even after their IPO.
In a dilutive secondary offering, the company issues new shares to raise more money. This increases the total number of shares, slightly reducing each shareholder’s ownership percentage.
In a non-dilutive offering, no new shares are created. Instead, early investors or insiders sell some of their existing shares to the public. The company doesn’t receive money from this, but it allows those shareholders to cash out.
Adding new shares to the pool may hurt existing investors at the time, but such a move can prove fruitful in the long run. If the money raised helps the company expand profitably, the business may grow in value faster than the dilution reduces ownership. Over time, that can benefit everyone involved.
Why Companies Do Secondary Offerings
There are several reasons why companies do secondary offerings after IPO. Some use the funds to build new facilities or acquire other businesses. Others may pay off debt or simply strengthen their balance sheets.
These additional offerings are a normal part of how a company issuing shares continues to grow. They can also signal that investor demand is strong enough to support more stock in circulation.
Stock prices often dip slightly because more shares are available. However, if investors trust the company’s long-term plan, prices usually recover once the new capital starts working toward growth.
Public vs Private Offerings
Understanding the difference between public and private offerings helps make sense of how businesses raise funds.
In a public offering, shares are sold openly on an exchange where anyone can buy them.
Consequently, private offerings sell shares to a limited group of investors, often institutions or wealthy individuals. Private offerings involve less paperwork but provide less exposure and liquidity.
Most large companies prefer public offerings because they reach more investors and can raise significantly more capital. For smaller or early-stage businesses, private offerings can be a useful first step before going public.
Evaluating an IPO Prospectus
Before investing in a new IPO, it’s worth learning how to evaluate a company’s IPO prospectus. Start by reviewing how the company plans to use the money it raises. Look for consistent revenue growth, experienced leadership, and clear descriptions of potential risks.
No single factor guarantees success, but a strong financial record, reasonable valuation, and a trustworthy management team are good signs. It’s also wise to compare the company’s story to others in the same industry to see if its business model stands out.
Frequently Asked Questions
What’s the difference between an IPO and a secondary offering?
An IPO is the company’s first time selling shares to the public, while a secondary offering happens later when new or existing shares are sold again.
Can a private company skip an IPO?
Yes. Some private companies choose a direct listing or merge with a SPAC to reach the public markets. These routes skip traditional underwriters but follow the same basic goal of selling shares to investors.
When more shares exist, each one represents a smaller percentage of ownership. But if the funds are used to expand successfully, the value of each share can still rise.
Why are underwriters important?
Underwriters handle the pricing, marketing, and legal details of an IPO. Their experience ensures that the company follows regulations and that the stock reaches investors smoothly.
Bringing It All Together
Every IPO and secondary offering tells a story of growth. The initial public offering marks a company’s first step into public ownership, while later secondary share issuances help it reach new goals. Both are essential parts of how businesses raise money and how investors get a chance to share in their success.
When you understand how a company goes public, what an IPO means, and how secondary offerings work, the financial world becomes clearer. You begin to see that each share of stock represents not just ownership, but participation in a company’s future.
Whether you’re reading your first prospectus or tracking your favorite stock, learning about how companies issue stock gives you the foundation to make smarter, more confident investing decisions.
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