How does an IPO raise money the company does not have?
Myriam asks:
For example, Google was only making around two billion dollars in revenue before it’s entry in the stock market, now it’s valued at $110 billion dollars. How is this justified?
For example, Google was only making around two billion dollars in revenue before it’s entry in the stock market, now it’s valued at $110 billion dollars. How is this justified?
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Investors often buy based on the expected future value of a company.
In the beginning, only the company owns all of the shares. With the IPO, they are selling those shares to the public, thus getting all of the money from those sold shares.
venture capitalists
The company goes to the public market to sell the private shares in the company. This is called the IPO. The IPO is underwritten by brokerage houses who buy the private shares and then re-sell these shares to clients. When the stock begins trading the public can buy these shares and the share price fluctuates with supply and demand for the stock. The market will price a stock based largely on future projected earnings. The high price of google for example signifies that the market expects high future earnings growth from the compnay. Should google disappoint the shares will be severely punished.
The company receives the money from the brokerage houses that underwrite the deal. This money is used to fund future operations of the company. The current valuation of the company is only relevant if the company sells more shares after the IPO. Google took advantage of the high stock price and sold even more shares at the market price. This is a good way for a company to raise money when the share price is high. The company must make sure that they do not sell too many shares otherwise the share pool will become too big and the earnings per share may not match investor expectations.
As to whether or not lofty valuations of a company are justified, that is a matter for debate.