Different Types of IPOs and How They Work

Companies looking to raise capital and expand often turn to the stock market. One of the most common methods is an Initial Public Offering (IPO), where private companies sell shares to public investors for the first time. This transition provides businesses with financial resources and visibility while offering investment opportunities to the public.

There are multiple ways a company can go public, each with its own structure and implications. Understanding these approaches is essential for anyone interested in how companies transition from private to public ownership.

Types of IPOs

Companies have several options when deciding how to go public, depending on cost, regulatory requirements, and market conditions. Each method affects valuation and investor participation differently.

Traditional IPO

A traditional IPO is the most common method. The company hires investment banks, known as underwriters, to manage the offering. These underwriters evaluate financials, determine the share price, and market the stock to institutional investors before it becomes publicly available.

The process starts with a roadshow, where company executives present to potential investors to gauge demand. Based on this feedback, underwriters set a final offering price and allocate shares. The company then lists on a stock exchange, such as the New York Stock Exchange (NYSE) or Nasdaq.

One advantage is price stability, as underwriters help manage demand and reduce volatility. However, it is expensive—underwriting fees typically range from 3% to 7% of the total funds raised. Additionally, early investors and employees often face lock-up periods of 90 to 180 days, preventing them from selling shares immediately.

Direct Listing

A direct listing allows a company to go public without underwriters. Instead of issuing new shares, existing shareholders sell stock directly on an exchange. This eliminates underwriting fees and lets the market determine the share price based on supply and demand.

Without institutional investors securing shares at a predetermined price, direct listings can lead to greater price volatility on the first day of trading. Companies that choose this method are typically well-known brands with strong financials and no immediate need for additional capital. Spotify (2018) and Coinbase (2021) both went public this way.

While direct listings reduce costs and avoid ownership dilution, they come with challenges. Without underwriters promoting the stock, initial investor interest may be lower. Additionally, since no new shares are issued, companies do not raise fresh capital, making this option less suitable for businesses needing funds for expansion.

SPAC (Special Purpose Acquisition Company)

A SPAC, or blank-check company, is a shell corporation created to acquire a private firm and take it public. Investors contribute funds to the SPAC before a target company is identified. Once a suitable business is found, the SPAC merges with it, allowing the private company to go public without a traditional IPO.

SPACs have gained popularity due to their speed and flexibility. Unlike traditional IPOs, which can take months or years, a SPAC merger can be completed in weeks. The target company also negotiates its own valuation rather than relying on underwriters.

However, SPACs carry risks. Investors commit capital without knowing which company the SPAC will acquire. If a target is not found within two years, funds must be returned. Additionally, SPAC sponsors typically receive a 20% stake in the acquired company, diluting existing shareholders. Regulatory scrutiny has increased, with the SEC introducing stricter disclosure rules to protect investors.

Dutch Auction

A Dutch auction IPO allows investors to bid on shares directly, determining the final offering price based on demand. Instead of underwriters setting a fixed price, potential buyers submit bids indicating how many shares they want and at what price. The highest price at which all available shares can be sold becomes the final offering price.

Google used this approach for its 2004 IPO. The main advantage is transparency—investors play a direct role in setting the stock’s value. It also reduces concerns about underwriters favoring institutional investors.

However, Dutch auctions can lead to unpredictable pricing and volatility. If too many high bids are placed, some investors may receive fewer shares than expected. If demand is lower than anticipated, the final price may be disappointing. Due to these uncertainties, Dutch auctions are rarely used.

How IPOs Work

Before a company can list on a public exchange, it must complete regulatory and financial steps to ensure compliance and investor confidence. The process begins with financial audits and the preparation of detailed disclosures.

Companies file an S-1 registration statement with the U.S. Securities and Exchange Commission (SEC), outlining financial health, business model, risks, and growth strategies. The SEC reviews this document and may request revisions before granting approval.

Once regulatory clearance is obtained, the company and its advisors assess market conditions to determine the best timing for the IPO. Economic factors, industry trends, and investor sentiment influence whether a company proceeds or delays its public debut.

Before the IPO, the company promotes the offering to potential buyers. Institutional investors, such as mutual funds and pension funds, often play a key role in establishing initial demand. Retail investors typically gain access after institutional buyers have secured their shares.

On the day of the IPO, trading begins once the exchange’s designated market maker matches buy and sell orders to establish an opening price. This price may differ from the initial offering price due to demand fluctuations. In cases of excessive volatility, trading may be delayed to prevent extreme price swings.

Advantages and Disadvantages of IPOs

Going public provides a company with financial and strategic benefits but also introduces new challenges.

One major advantage is access to capital, which can be used for expansion, research and development, debt reduction, or acquisitions. Unlike venture capital or loans, IPO funding does not require repayment. This can also improve a company’s creditworthiness, making it easier to secure favorable loan terms.

Another benefit is increased liquidity for existing shareholders, including early investors and employees with stock options. Once shares are publicly traded, stakeholders can sell their holdings at market value. A public listing can also enhance a company’s credibility with customers, suppliers, and business partners.

However, going public comes with increased regulatory scrutiny and compliance costs. Public companies must follow strict financial reporting standards under regulations like the Sarbanes-Oxley Act, which mandates internal controls and external audits. These requirements can cost millions of dollars annually.

Executives also face pressure to meet quarterly earnings expectations, which can lead to short-term decision-making that prioritizes immediate stock performance over long-term growth. Shareholder influence adds complexity, as activist investors may push for strategic changes that align with their interests rather than the company’s long-term vision.

Stock price volatility can impact employee morale, especially if compensation is tied to equity. A declining share price can reduce the perceived value of stock options, making it harder to attract and retain top talent.

Recent Trends in IPOs

Market conditions have significantly influenced IPO activity. After a surge in public offerings during 2020 and 2021—driven by low borrowing costs and strong investor enthusiasm—IPO volumes declined sharply in 2022 and 2023 as the Federal Reserve’s rate hikes increased the cost of capital. Many companies delayed or reconsidered their public debut, particularly in interest rate-sensitive sectors like technology and consumer discretionary industries.

Investor sentiment has also shifted, with greater scrutiny on profitability and sustainable growth. Companies that previously attracted strong IPO demand despite high revenue growth and steep losses now face pressure to demonstrate clear paths to profitability.

Additionally, post-IPO performance has become a greater concern. Many high-profile listings from past years have struggled to maintain their initial valuations, reinforcing the importance of realistic pricing and strong fundamentals.

Regulatory Requirements for IPOs

Companies going public must comply with regulations designed to protect investors and ensure market transparency. In the United States, the SEC oversees the IPO process, enforcing disclosure rules and financial reporting standards.

A key requirement is filing the S-1 registration statement, which provides a detailed overview of the company’s financial condition, business model, risk factors, and intended use of IPO proceeds. Companies must also comply with the Sarbanes-Oxley Act, which mandates internal controls and independent audits to prevent financial misstatements.

Stock exchanges like the NYSE and Nasdaq impose listing requirements, including minimum revenue thresholds and corporate governance standards. Failure to meet these obligations can result in delays, penalties, or even rejection of an IPO application.