Private and public companies are like eggs and chickens. The egg hides behind its shell; no one really knows what’s going on in there. A public company, however, gives the entire world access to its financial statements. It regularly holds calls for its shareholders, which own the company’s stock. With a chicken, you can pick it up, inspect it, and it can’t fly away. Same same with a public company.

For a private company to go public, it must crack its shell in the form of an IPO: initial public offering. Aka when a company sells shares of its stock publicly on a stock market exchange.

A trip to the farm: Stock Market Exchanges

Chickens live on farms (or in hipsters’ backyards). Stocks live in stock exchanges.

Think of an exchange like olden times – Farmer A goes to the local market and sees a beautiful donkey for sale. He offers Farmer B $100 for the donkey. Farmer B says, nah, I want more than $100. A duke passing by overhears this and says, I’ll pay $300! Farmer B agrees, and the donkey is tied to the back of the duke’s wagon. Farmer A goes home and cries.

In other words, an exchange is where people buy and sell things.

There are many domestic and international exchanges where people can buy and sell stocks, ETFs, commodities and other assets. The two main stock market exchanges in the US are the NYSE and the NASDAQ.

NYSE = New York Stock Exchange. Based in NYC. If you’re familiar with the famous bronze raging bull statue (and the Fearless Girl), that’s where the NYSE lives.

NASDAQ = Stands for National Association of Securities Dealers Automated Quotations. World’s first electronic stock market and second largest market in the world (#1 is NYSE). Also based in NYC.

Egg to Chicken – IPO Basics

When a company wants to issue an IPO, it fills out a registration form listing all the company deets like financials and business operations and sends it to the Securities and Exchange Commission (SEC). After a company goes public, it must file its financial statements quarterly with the SEC. Once SEC approved, the company finalizes a stock ticker symbol and fills out exchange applications. Exchanges are pretty picky about which companies they will trade. They have certain requirements, and if the company doesn’t meet them, don’t even bother applying. #byefelicia

If all requirements are met, and the company’s application is accepted by the exchange, then the company and exchange – with the SEC’s help – arrange an IPO date. Somebody pop the bubbly.

Overachiever companies that want to increase their liquidity (the ease at which its shares can be bought or sold) can apply to list on multiple exchanges. This is called a dual-listing.

Pricing a Chicken – IPO Valuation

Companies typically hire investment banks to prepare their IPO and determine an IPO price, which is the price the stock will be listed at on the exchange. The investment bank and a crew representing the company meet and greet with institutional investors – think big global investment firms that have lots of cash money – and brag about the business and its awesomeness. Investors who have confidence in the company will say, yeah sign me up, and buy shares of the company’s stock at the bank’s determined IPO price, hoping the price will increase once the anyone can buy the stock in the open market.

How do investment banks determine the magic IPO stock price? There are a couple of factors:

Comparable prices of similar companies

In the biz world, a list of similar things to the thing you are trying to price is called a comp sheet. If a sportswear fashion retail company is going public, a banker might put together a comp sheet with valuation multiples* of Lululemon, Nike, and Gap, which owns Athleta. (My wardrobe is 90% activewear, in case you were wondering.)

*If you read valuation multiple and thought, wutttt is that: it’s a multiple dividing one financial metric by another to help financial analysts compare companies. There are lots of different ones, and the importance of a certain multiple depends on the company’s industry focus. (For example, an inventory metric matters for a retail company, but not for a tech company that sells a digital product.) Valuation multiples are one thing bankers use to determine an IPO price.

Initial demand

When the company meets with investors, bankers use these meetings to gauge interest in the business and hear directly from investors how much they want and what they will pay

Market Conditions

If a tech company does an IPO in the middle of a tech boom, its IPO stock price will likely open at a higher price than a tech company going public during a recession. Companies will sometimes delay their IPOs when market conditions are being a downer.

Growth Potential

In stock market world, EVERYONE cares about growth. Stock prices often reflect the market’s current and future expectations for a company’s outlook. Fun fact: When Amazon went public, it took seven years for it to make a profit. Why invest in something that literally can’t pay the bills? ‘Cause if a company has a positive growth outlook, the stock price will consequently go up, and you’ll get #paid. Those early-stage Amazon investors probably feel pretty smug.

RECAP

Sometimes, chicken eggs become chickens. And sometimes, private companies become public companies. Public companies trade on stock market exchanges. The two major US exchanges are the NYSE and the NASDAQ. To trade on an exchange, a company must pass the SEC’s inspection and meet exchange requirements. Companies hire investment banks to help them through the initial public offering process, who also help determine the opening stock price. For stocks, growth is king.