Types of IPOs: The Different Ways to Go Public
Did you know there are different types of IPOs? If you’re not familiar with IPOs or the process, you’ve found the perfect place. Here you’ll find a brief overview of what it is and the different ways to go public. Let’s take a look…
Types of IPOs
IPO stands for initial public offering. It’s when a private company offers stock on the public market for the first time. This allows retail investors access to company shares and raises funds for the company. IPOs also transition the company from private to public.
Public companies have to follow different rules than private companies. In 1934, the U.S government created the Securities Exchange Commission (SEC). It was to help encourage retail investors’ confidence in the market after the 1929 market crash. The goal of the SEC is to enforce the laws against market manipulation. As a result, it requires public companies to file annual and quarterly reports. This way, people know what they’re investing in and the risks associated with it.
Now, there are two main types of IPOs we’re going to cover.
Fixed Price
A fixed price IPO is simply that—fixed. The price is set and doesn’t change. However, the final price is typically unknown until the offering. This is because companies consider a variety of factors in the pricing, such as market conditions and investor demand. To participate in this type of IPO, investors have to pay the full fixed price.
However, keep in mind the IPO price may not be what the company’s shares open at on the first trading day. For example, the Airbnb (Nasdaq: ABNB) IPO priced at $68. But its opening trade price was $146. To better understand the IPO process, check out that link.
Book Building
The second type of IPO is book building. Instead of a fixed price like the one above, this process involves bids. The company provides a price band for investors. This includes the floor and cap bids. The floor is the minimum whereas the cap is the maximum. This gives a pricing guideline.
During bidding, investors say how many shares they want and what they’re willing to pay for them. Once bidding closes, the company decides the final price.
Although these are the two main types of IPOs, it can be categorized further based on how a company decides to go public.
Types of IPOs: Different Ways to Go Public
Companies choose an IPO method based on multiple factors, with market conditions being one of the most important. There is no one right way, and each company will pick what works best for them.
Traditional
The traditional IPO is a standard process most companies take. It involves a lot of money and time, usually anywhere from months to years. The process involves underwriters, roadshows, pricing and the IPO aftermath. This includes the greenshoe option, street research and the lock-up period.
SPAC
SPAC IPOs are becoming more popular. SPAC stands for special purpose acquisition company, or blank-check company. It has no business operations. Instead, it goes public through a traditional IPO process to raise funds. Since there aren’t any operations to report on, the IPO process for SPACs is much quicker than a standard company IPO.
The SPAC then has a period of time, typically two years, to find an acquisition. This is a private company the SPAC will make a deal with, resulting in a public company. SPACs became popular in 2020 during the coronavirus pandemic due to uncertain market conditions.
Direct Listing
This type of IPO cuts out the middle man. Unlike a traditional IPO, there are no underwriters. Direct listings are known for being cheaper and faster. In this method, existing employee and investor shares are listed directly onto the exchange. They’re ideal for established companies with a loyal customer base. Direct listings can save money and avoid diluting existing ownership.
Reverse Merger
Reverse mergers are similar to another type of IPO we’ve covered: SPAC IPOs. There’s one difference, though, you might guess from the name. Instead of the getting acquired, the private company is the one doing the acquiring. In this process, a private company merges with a “shell company,” or dormant public company.
Although SPACs are considered shell companies, they’re formed for the sole reason of acquiring another company rather being acquired themselves.
Spinoff
A great real life example of this type of IPO is Starlink. Elon Musk promised investors a Starlink IPO is in the future. Starlink is a project of Musk’s newest endeavor SpaceX. So, when Starlink goes public, it will likely be “spun out” into its own public entity. It’s parent, SpaceX, will remain private. Any shares from the Starlink IPO will be Starlink stock, not SpaceX.
This is a great way for established companies to reap the benefits of a public company while still maintaining private status. For someone like Musk, it lets him continue to run SpaceX his way without as much interference of public interest, like his company Tesla (Nasdaq: TSLA).
Dutch Auction
Most of the IPO methods covered so far lean towards fixed pricing. But a Dutch Auction opts for the book-building option. In this type of IPO, the company determines a number of shares and minimum bid price. Bidders then say how many they’re willing to buy and for how much.
When bidding closes, the company allots the shares to the highest bids. The highest bid receives shares, then the second-highest and so on until all shares are allocated. However, the price isn’t the highest bid. Instead, it’s the lowest successful bid.
A successful bid is one that wins share allocation. So, any bidders who receive shares are considered successful. As a result, whatever the price is of the lowest successful bid is the price all successful bidders pay. For example, if you bid $200 but the lowest successful bid is $150, you’d pay $150.
Types of IPOs: The Bottom Line
There are a few different ways for a company to hit the public markets. However, there are some key differences between different types of IPOs. If you’re considering investing in a newly-public company, make sure to do your own research. You should always be aware of the risks with investing as returns are never guaranteed.
For more information on upcoming IPOs, check out our IPO calendar. It’s updated daily to give you the most recent information on companies going public. Furthermore, check out our top recent IPOs to see the top-performing public debuts each months.
About Amber Deter
Amber Deter has researched and written about initial public offerings (IPOs) over the last few years. After starting her college career studying accounting and business, Amber decided to focus on her love of writing. Now she’s able to bring that experience to Investment U readers by providing in-depth research on IPO and investing opportunities.