Stock Basics· Lesson 12 of 12· 5 min

IPOs: How a Company Goes Public

A company's first sale of shares to the public is an IPO. Tell the primary market from the secondary market: only the money raised at issue goes into the company's pocket.

This lesson is free: sign up for an account to use the interactive simulation

Every lesson has an interactive simulation you can drag and play, plus a quick quiz. Sign up free to use them and save your progress automatically. Here is the text version of this lesson.

Not sure yet? Try the first lesson (no sign-up needed)「What Is a Stock?」。

Text version · Stock Basics, lesson 12: “IPOs: How a Company Goes Public”

A company's first sale of shares to the public is an IPO. Tell the primary market from the secondary market: only the money raised at issue goes into the company's pocket.

IPO: a company sells stock for the first time

In an IPO, the company issues new shares and sells them to investors at the offer price, using the money raised to grow the business. Afterwards the stock is listed on an exchange and anyone can trade it.

Primary vs secondary market

Issuing new shares, with the money going to the company, happens in the primary market. Investors trading with each other after listing is the secondary market. Everyday stock trading happens almost entirely in the secondary market, and the company doesn't get that money.

New shares dilute existing shareholders

Total shares go from 8 million to 10 million. Existing shareholders keep the same number of shares, but their ownership drops from 100% to 80%. That's dilution. In exchange, the company has a big pile of new cash.

IPOs aren't a sure win

After listing, buyers and sellers in the secondary market set the price. It may soar on day one, or slide below the offer price. That's a broken IPO, and anyone who bought at the offer price loses money.

Key takeaways

In an IPO the company issues new shares and receives the money raised. This happens in the primary market.
After listing, investors trade with each other in the secondary market. Price moves there bring the company no new money.
Issuing new shares dilutes existing shareholders' stakes, but the company gains cash, so the whole "pie" gets bigger too.
After listing, the price may soar or fall below the offer price (a broken IPO). Buying IPOs is not a sure win.

Try it yourself

You can do these exercises in this lesson's interactive simulation:

Keep the defaults (2 million new shares at a $10 offer price): how much does the company raise? How far does the existing shareholders' ownership drop?
Drag "New shares issued" to 4 million: what's the existing shareholders' ownership now? Did the number of shares they hold change?
Switch to "② Start trading", where the price starts 50% above the offer price: how much do 1,000 allotted shares make? Does "Capital raised" change too?
Click "Simulate a broken IPO: down 20%": how much do 1,000 allotted shares lose? Does the company have to give back the money it raised?

Quiz and explanations

1. Before listing, a company has 8 million shares. In its IPO it issues 2 million new shares at $10. How much money does it raise?: Answer: $20 million.Money raised = new shares issued × offer price = 2 million × $10 = $20 million.
2. Same company: after the IPO, what stake do the existing shareholders (the founding team) hold?: Answer: 80%.8 million ÷ (8 million + 2 million) = 80%.
3. After listing, the price rises from $10 to $15. Does the company get money directly from this rise?: Answer: No, secondary-market money moves between investors.The rise happens in the secondary market, where money flows from buyers to sellers. The company was paid once, at issue; to raise more later it has to issue new shares.

Terms in this lesson

dilution (Dilution): When a company issues new shares, existing shareholders own the same number of shares but a smaller slice of the company.
IPO (Initial Public Offering): When a company sells shares to the public for the first time and lists on an exchange, using the money raised to grow.
broken IPO (Broken IPO): When a new stock falls below its offer price after listing, leaving investors who bought at the offer price with a loss.
offer price (Offer Price): The price new shares are sold to investors at in an IPO, set by the company and its underwriters beforehand.
primary market (Primary Market): Where a company issues new shares directly to investors and the money raised goes to the company.
secondary market (Secondary Market): Where investors trade listed shares with each other: money moves between buyer and seller, and the company gets none of it.