An Initial Public Offering (IPO) is one of the most high-profile transactions in investment banking. It is the process by which a private company sells shares to public investors for the first time, listing its stock on a public exchange. For aspiring bankers, understanding the IPO process inside and out is essential: it comes up frequently in investment banking interviews and is a core part of the work you will do in equity capital markets (ECM) and many industry coverage groups.
In this guide, we will walk through every major step of the IPO process, explain the role investment banks play, discuss how shares are priced and allocated, and cover common IPO-related interview questions you should be prepared to answer.
What Is an IPO?
An IPO (short for Initial Public Offering) is the first time a company offers its shares for sale to the general public. Before an IPO, a company is privately held, meaning its equity is owned by founders, employees, venture capitalists, private equity firms, or other private investors. After the IPO, the company’s shares trade on a stock exchange like the NYSE or Nasdaq, and anyone with a brokerage account can buy or sell them.
Companies pursue IPOs for several reasons. The most common include raising capital to fund growth, providing liquidity for early investors and employees who want to cash out some of their holdings, increasing the company’s public profile and credibility, and using publicly traded stock as currency for future acquisitions. In some cases, an IPO is also driven by contractual obligations or regulatory requirements.
The Role of Investment Banks in an IPO
Investment banks are central to the IPO process. When a company decides to go public, it hires one or more banks to serve as underwriters. The lead underwriter (often called the “bookrunner”) manages the entire offering process, from preparing the registration documents to pricing the shares and allocating them to investors.
For large IPOs, there is typically a syndicate of several banks involved. The lead left bookrunner has the most prominent role and earns the largest share of fees. Other banks may serve as joint bookrunners, co-managers, or passive bookrunners. The hierarchy matters a great deal on Wall Street, and banks compete fiercely for lead left positions on marquee IPOs.
The underwriting banks earn fees, typically around 3% to 7% of the total proceeds raised, depending on the size of the deal. Larger offerings tend to have lower fee percentages, while smaller deals command higher percentages. Investment banks also benefit from the ongoing relationship with the newly public company, which often leads to future advisory work in M&A, debt offerings, and follow-on equity raises.
Step-by-Step: How the IPO Process Works
1. Selecting Underwriters (the “Bake-Off”)
The process begins when a company decides it is ready to go public. The company’s management and board will invite several investment banks to pitch for the underwriting mandate. This competitive process is sometimes called a “bake-off.” Each bank presents its views on valuation, positioning, the ideal timing for the offering, and its distribution capabilities, meaning how effectively it can place shares with institutional investors.
After evaluating the pitches, the company selects its lead underwriter(s) and the broader syndicate. The choice is often influenced by the bank’s sector expertise, research coverage, and relationships with key institutional investors.
2. Due Diligence and Filing the S-1
Once the banks are hired, the intensive preparation phase begins. The company, its lawyers, and the underwriting banks work together to prepare the S-1 registration statement, which is filed with the Securities and Exchange Commission (SEC). The S-1 is a comprehensive document that includes the company’s financial statements, a description of its business and risk factors, details about management and ownership, and the intended use of proceeds.
This phase involves extensive due diligence. The bankers dig into the company’s financials, business model, competitive landscape, and growth prospects. The goal is to ensure that the S-1 is accurate, complete, and presents the company’s story in the most compelling yet truthful way possible. Understanding how the three financial statements link together is critical during this phase, as the company’s financial disclosures must be thoroughly vetted.
3. SEC Review and Amendments
After the S-1 is filed, the SEC reviews it and typically comes back with comments and questions. The company and its advisors respond to these comments and file amended versions of the S-1. This back-and-forth can take several weeks or even months. The SEC’s role is not to evaluate whether the company is a good investment: rather, it ensures that the disclosures are adequate so investors can make informed decisions.
4. The Roadshow
Once the SEC has cleared the registration statement, the company and its bankers launch the roadshow. During the roadshow, which typically lasts one to two weeks, the company’s management team (usually the CEO and CFO) and the lead bankers travel to major financial centers to present the investment case to institutional investors like mutual funds, hedge funds, and pension funds.
The roadshow is a critical phase. It is the company’s chance to tell its story directly to the investors who will ultimately decide whether to buy shares. Bankers play a key role in coaching management on how to present, handling logistics, and gauging investor interest. The feedback collected during the roadshow heavily influences the final pricing of the IPO.
5. Book Building and Pricing
During and after the roadshow, the underwriters engage in “book building.” This means they collect indications of interest from institutional investors: how many shares each investor wants to buy and at what price. Based on this demand, the underwriters and the company set a price range (which is included in the preliminary prospectus) and ultimately determine the final offer price.
Pricing an IPO is both an art and a science. The banks use comparable company analysis and DCF analysis to establish a valuation framework, but the final price is heavily influenced by investor demand. The goal is to set a price that is attractive enough to generate strong demand and a healthy first-day “pop” in the stock price, but not so low that the company leaves too much money on the table.
6. Allocation
After the price is set, the underwriters allocate shares to investors. This is one of the most important and sensitive parts of the process. Not every investor who indicated interest will receive shares: typically, the offering is oversubscribed, meaning demand exceeds the number of shares available. The lead bookrunner decides how to distribute shares, generally favoring long-term institutional investors who are likely to hold the stock rather than flip it for a quick profit on the first day of trading.
7. Trading Begins
On the day of the IPO, the stock begins trading on the exchange. The opening price may differ from the offer price depending on market demand. The underwriting banks play a stabilization role in the early days of trading, sometimes buying shares in the open market to support the stock price if it dips below the offer price. This stabilization is facilitated by the “greenshoe option” (also called the overallotment option), which gives the underwriters the right to sell up to 15% more shares than originally planned.
Key IPO Concepts You Should Know
Lock-Up Period
After an IPO, insiders (including founders, executives, and pre-IPO investors) are typically subject to a lock-up period of 90 to 180 days during which they cannot sell their shares. This prevents a flood of insider selling from depressing the stock price immediately after the offering. When the lock-up expires, it is common to see increased selling pressure and sometimes a temporary decline in the stock price.
Greenshoe Option
The greenshoe option allows underwriters to sell up to 15% more shares than the original offering size. If demand is strong and the stock trades above the offer price, the underwriters exercise the option by purchasing additional shares from the company at the offer price and selling them at the market price. If the stock drops below the offer price, the underwriters can buy shares in the open market to stabilize the price.
Quiet Period
SEC regulations impose a “quiet period” around the IPO during which the company and its underwriters are restricted in what they can say publicly about the company. This is designed to prevent hype and ensure that investors make decisions based on the information in the prospectus rather than promotional statements.
Firm Commitment vs. Best Efforts Underwriting
There are two main types of underwriting arrangements. In a firm commitment underwriting (which is the standard for most IPOs) the underwriting banks purchase all of the shares from the company at a slight discount to the offer price and then resell them to investors. This means the company is guaranteed to receive its proceeds regardless of how the shares sell in the market. The underwriters bear the risk of being stuck with unsold shares.
In a best efforts underwriting, the banks simply agree to use their best efforts to sell the shares but do not guarantee that all shares will be sold. This is more common for smaller, riskier offerings. For most IPOs at major banks, firm commitment is the standard.
Why Do IPOs Often “Pop” on the First Day?
It is common for IPOs to see a significant increase in stock price on the first day of trading, sometimes 10%, 20%, or more. This phenomenon is known as “IPO underpricing.” There are several theories for why this happens. From the company’s perspective, a modest first-day pop is desirable because it creates positive headlines and leaves investors with a good impression. From the underwriters’ perspective, pricing the deal at a slight discount ensures the offering is fully subscribed and keeps institutional investors happy, since these investors provide repeat business for future deals.
However, too large a pop can be a problem. If a stock doubles on day one, the company effectively left half of its potential proceeds on the table. This has been a point of criticism in high-profile IPOs where the first-day return was extremely large.
Alternatives to a Traditional IPO
In recent years, several alternatives to the traditional IPO have gained traction. A direct listing allows a company to list its shares on an exchange without issuing new shares or using underwriters in the traditional sense. The company simply allows existing shareholders to sell their shares to the public. This approach avoids underwriting fees and dilution but does not raise new capital. A few high-profile companies have gone public via direct listing.
SPACs (Special Purpose Acquisition Companies) were another popular alternative for a time. A SPAC is a blank-check company that raises money through its own IPO and then merges with a private company, taking it public. SPAC activity surged and then cooled significantly as regulatory scrutiny increased and investor returns disappointed.
Common IPO Interview Questions
If you are preparing for investment banking interviews, you should be ready to answer questions about the IPO process. Here are some common ones:
- “Walk me through the IPO process.” Cover the key steps: selecting underwriters, due diligence, filing the S-1, SEC review, the roadshow, book building, pricing, allocation, and trading.
- “Why would a company want to go public?” Raise capital, provide liquidity for existing shareholders, increase public visibility, use stock as acquisition currency.
- “What is the greenshoe option?” An overallotment option allowing underwriters to sell up to 15% more shares to stabilize the stock price.
- “What is the difference between a firm commitment and best efforts offering?” Firm commitment means the banks buy all shares and bear the risk; best efforts means they try to sell shares but do not guarantee it.
- “How do you value a company for an IPO?” Use comparable company analysis, precedent IPO transactions, and DCF analysis, then adjust based on investor feedback during the roadshow.
For more technical concepts that come up in these interviews, check out our guide on enterprise value vs. equity value and our technical cheatsheet.
Want Personalized Interview Coaching?
If you are serious about breaking into investment banking, the best thing you can do is work with someone who has been through the recruiting process and knows exactly what top banks are looking for. At Wall Street Mastermind, we have helped over 2,500 students land offers at every bulge bracket and elite boutique bank on Wall Street. Book a free strategy call to learn how we can help you prepare for your interviews and maximize your chances of landing the offer.
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