Today is a big day for Groupon. The group-buying site is having an initial public offering (IPO), which means that it will sell stock to the public for the first time.
Up until now, the three-year-old site has been operating on private money that it received from investors. This is normally how companies begin—with private “seed” funding that gets them off the ground. Investors like venture capital (VC) firms give start-up money to businesses in the hopes that those businesses will become huge—and moreover, profitable—one day.
But at a certain point, companies could want more money than investors have given them—either to expand their business, pay their debts or cover other expenses—and may be unwilling to accept any more cash in that form. This could be for any number of reasons: Perhaps the investors want to sell their shares in the company to cash in on their profits, or perhaps the company doesn't want to take out a loan to raise money. Whatever the reason, it's at this point that the company might instead decide to have an IPO.
What to Know About an IPO
An initial public offering is the equivalent of a “private” company “going public.” For example, any person can buy a share of a public company like Microsoft, Disney, or Morgan Stanley on a public stock exchange. Private companies like Groupon, on the other hand, are invite-only for investors.
(Back up—what exactly is a share? Find everything you need to know, here.)
Going public will mean both a lot of new cash for the company—and a potential loss of power and control for the CEO and the rest of the management team. After all, once Groupon is public, it’ll suddenly be accountable to a slew of shareholders mostly concerned with the ever-climbing price of the stock.
How Companies Prepare to Go Public
To have an IPO, a company goes to an investment bank for a valuation of their business. The investment bank divides that amount, the “value of the company,” into a certain number of shares. The company decides to sell a certain number of those shares to the public, while keeping the other shares. So, for example, Groupon is selling 30 million shares, equivalent to 4.7% of the company.
Many IPOs happen without much fanfare. But for companies that become well-known even when they’re privately held, like Groupon or LinkedIn, investors tend to jump on the stock the first day, driving up the value of a share quickly. Groupon will start by offering shares of its stock for $20, putting its valuation at $12.65 billion, but if demand is high, that price could rise fast.
What This Means for Investors
An IPO of a new company appeals to investors because, if the company succeeds in the future, those who get in on the ground floor and buy shares during the IPO will see the value of their shares rise greatly in the future.
At the same time, IPOs are also risky because there is less financial information about companies that are privately held. Public companies are required to release quarterly financial reports, information on internal proceedings and balance sheets. So people who buy during an IPO do so without a long history of insight on the company's financial health, which they would have if they invested in a more established company.
Of course, unless you’re a pro investor, we think it’s best not to invest in individual stocks at all. That’s because doing so comes with much higher risk than buying into a mutual fund. Here’s a rundown on how to choose the investments that make up your retirement account, including how to choose funds.
For more on stocks, bonds, mutual funds and how to invest with confidence, check out our Investing Courses.