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Stock IPO - What It Is and How It Works

An initial public offering is another term to describe a stock IPO. It's also sometimes known as a flotation. This is what happens when any company offers any common stock to the public or shares it with the public for the very first time. This is a practice which is very commonly used by a newer, small company attempting to raise additional capital for the purpose of expanding. This practice is also commonly used by companies whose stock is private, but they want to trade their stock publicly.

A stock IPO works by the issuer or company, using an underwriter company to figure which type of security should be issued. It will be either common or preferred. The underwriter is responsible for determining what the best selling price should be for the stock, and when the best time would be to offer the stock on the market. When a company chooses to list its stock on a publicly-traded exchange, the money that investors pay for the stock goes directly to the company. After the original issue of the stock, when it's traded publicly, the money goes to the investors. This is a good way for a new company to get a large number of investors and capital to put into future growth of the company.

One or more underwriters, also known as investment banks, are involved in stock IPO transactions. The issuer and lead underwriter have a contract to sell the shares. The investors are approached by the underwriter who offers shares at a specific price. How the stocks are priced may be done in several ways. The forms of contract can be best effort, firm commitment, or all-or-none. Bought deal and Dutch auction are two other forms of pricing. When the stocks are sold, the underwriter receives a commission. The commission is figured by the percentage of the shares that are sold. This is also known as the gross spread. The investment bank that sells the biggest percentage of the shares receives the highest commission. It can be as high as 8 percent.

Various countries may have different rules regulating a stock IPO, depending upon the countries involved. For stocks being sold in Europe, some of the other parties involved may be located in the United States, Canada, or Asia. The investment bank that's the head underwriter for the sale is usually also the main bank for the additional groups involved in the sale. Public stock sales can involve investors from various institutions and clients of the investment banks. Sales of this type in the United States must be cleared by the Securities and Exchange Commission.