Not Just Any Investor

When stocks are initially sold during an IPO, the company gets the money for the sale of the stocks no matter who buys them. However, in the long term, certain kinds of investors can be bad for the company's value. The "bad" kind of investors are speculators, who really don't want to invest in the company's future. They just want to buy shares cheap and sell them at a higher price to make a quick buck. This is known as flipping a stock, and while it isn't illegal, many brokerage firms discourage it by punishing traders who do it (usually by denying them access to future IPO opportunities).

Ready, Set, IPO

Having an IPO is not so much an event as it is a process. It takes months of planning to prepare a company to go public. A board of directors must be assembled, accounts audited for accuracy, consultants and advisers hired, and a financial printer contracted. In fact, a whole cast of characters must take the stage to help an IPO happen.

The most important character is probably the underwriter, an investment banker who works for an investment company. Underwriters have the distribution channels and business community contacts that can get a company's shares out to the right investors. They will also help set the initial offering price for the stocks, work to create enthusiasm for the stock, and assist in creating the prospectus. The prospectus is an important document that describes the company in great detail to potential investors.

Once the prospectus has been drafted, it is reviewed by the SEC. SEC approval only means that the prospectus follows the regulations for such documents -- it says nothing about the quality or future profitability of the company.

Following SEC approval, company executives go on the road show, otherwise known as the dog-and-pony show. This is a tour of major cities and cities where important brokerage houses have their headquarters. At these invitation-only slide shows (a few elite investors will even get one-on-one presentations), potential investors are given "goodie bags" containing calendars, pens, samples of the company's product, and whatever else might help investors think favorably about the company. One fashion designer even stocked a road show with famous supermodels.

Although the goodies and supermodels take the spotlight, the road-show crew also includes a Wall Street analyst who will give positive opinions about the company's future profitability. However, no one involved with the company is allowed to talk publicly about anything that isn't in the prospectus in the period leading up to the IPO (Google broke this rule in the weeks leading up to its IPO -- see The Google IPO section to learn more).