Introduction

There are millions of corporations in the United States, but only a small percentage is "public."  That is, the ownership interest in the company?the shares of its common stock?may be bought and sold on an exchange or market.  Most corporations are closely held; that is, there is a well defined number of owners of the company and these owners don't change radically over time.  Most companies can survive and thrive without the added expense due to regulatory oversight of "going public"; that is, of creating the ability to sell shares to any interested party?the general public.

The SEC or Securities and Exchange Commission is an agency of the government of the United States charged with overseeing securities' exchanges and markets and enforcing federal securities laws.  The agency was formed in response to the market crash in 1929.  The first chairman of the SEC was Joseph Kennedy, the patriarch of the famous Kennedy family and father of President John F Kennedy.  The SEC describes its mission as "to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation."

Early days before an IPO 

A company might go through a number of rounds of private financing—stages in which wealthy investors put money into the company to fuel its growth.  If the company is very successful, it eventually reaches a stage when it requires substantial funding.  At this point the company might “go public.”  In private financing, the shares of the company are held by a few individuals.  These shares are “illiquid”: it’s not easy to sell them and convert them into cash.  For one thing, there may not be a lot of buyers.  If there are buyers, they might differ on what they think the company is worth.  Bringing a company public—selling it to the public at large—can help alleviate a lot of these issues.

There are many venture capitalist and private equity firms in the United States which take a position in a firm long before it goes public: they provide capital, funding, in return for shares of common stock of the company.  In fact, the vast majority of companies in which they invest fail before they ever get to the point of an IPO.  The company spends the invested capital, executing its business plan in an attempt to increase the value in the company.  There are typically many rounds of venture financing, with the illiquid shares increasing in value in each round.  At some point, the owners of the firm, the venture capitalists at this point, may elect to deploy their 'exit strategy' and bring the company public.

What a company has to do to "go public" 

Let’s say business is booming and the future looks even brighter.  The company might decide it’s time to share the wealth.  Management approaches an investment bank and asks them to “bring the company public.”  Documents are filed with the SEC (Securities and Exchange Commission), a statutory body with regulatory oversight on stock markets.  Permission to bring the company public is sought and obtained.  A prospectus is written that details two years of financials, goals for the future and various risks that might be faced.  This prospectus is often called a red herring!  The prospectus is made available to anyone who wants to read it.  The underwriting company then facilitates a “road show” where the company visits large institutional investors and makes a presentation about the value of investing in the new company.  A ticker symbol is assigned to the company—a ticker symbol is a group of letters, a shorthand way of writing the company name.  A day is chosen to bring the company public—to have an initial public offering, an IPO.  A price range for the shares has been established.  On the day of the IPO, the shares are transferred somewhere in the price range from the investment bank (or banks) to institutional investors and the public.  The shares can then be traded!  That is, the owners of the shares can sell to others through a mechanism to be discussed.

How a company issues shares 

The number of shares a company can issue is given in the company charter—kind of like the constitution for the company.  The charter stipulates the number of shares a company is authorized to issue.  When shares are sold to the public at large, they are called issued shares; shares held by people and institutions are referred to as “issued and outstanding”: they are, in principle, available for trade.  Companies seldom issue all the shares that the charter authorizes.  Before more shares are issued, the board of directors must get permission from shareholders—the people who own the issued shares.  Finally, sometimes a company will buy back its own shares.  Now, I’m talking about the company itself making the purchase (remember a corporation is like a legal person in some respects) not employees of the company. If a company buys back its own shares, these shares are still called “issued,” but they are not outstanding.

Let’s say a charter authorizes a company to issue 100,000,000 shares of common stock.  If the company sells 5,000,000 shares to the public through an investment bank, there are now 5 million shares of that company issued and outstanding.  If the company decides to buy back 1,000,000 shares, it does so like any other purchaser.  The company goes to a broker and makes purchases on the open market.  Once the shares are bought, there are still 5 million shares issued but only 4 million shares outstanding.

The company can sell shares of its treasury stock (the shares it bought on the open market) without seeking the approval of the shareholders through its board.  Issuing more shares normally requires action by the board of directors of the corporation.