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An IPO

The initial public offering of our online sock company. Created by Sal Khan.

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  • blobby green style avatar for user adeeb.qasem
    The IPO seems to work well for everybody: IB gets 7%, Company has cash to go on with its marketing and operations, Main owner and the VCs have the ability to liquidate!

    My question is; why would any company decide not to go for an IPO?
    (16 votes)
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    • blobby green style avatar for user matthewdines
      One reason is that there are a host of regulatory requirements which come with being a listed company which you can avoid by remaining in private hands. Another is that you are less troubled by arbitrary revaluations when the market takes a dive.
      (11 votes)
  • blobby green style avatar for user cmares58
    A few questions

    1. The IPO is the only actual time that the company raises money through stocks? So then the price of the stock there after does not really effect the company at all in terms of how much capital it has?

    2. It seems that the founder of the company and early investors give up a huge percentage of their stake in the company. So why would they want to do this? How do founders of companies end up owning huge amount of shares later unless they were already super wealthy to begin with
    (9 votes)
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    • blobby green style avatar for user adlosh
      Sal gave a very extreme example, many times a company will issue not more than 10 percent or even less of a stake in the company. The founders will usually want to keep a nice stake in the company especially if they really believe in their enterprise, because chances are that as time goes on it will become worth even more.

      Sometimes VC want to cash in on their early investment, so then they want to liquidate their position. Many times its because the stock market is in one of those mania moments like the late 90's and they know that if they cash in now they could really reap a fortune on their investment.
      (5 votes)
  • blobby green style avatar for user albrightde1
    Before an IPO, how difficult is it for VC's and angel investors to cash in on their shares? Is it difficult for them to find a buyer without the public market?
    (4 votes)
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    • leaf orange style avatar for user zack.ramza
      It can be difficult for VCs and Angel Investors to cash in without an IPO to take the company public, but many VC firms have connections to well-to-do private investors or institutions that can buy out their stake in a company/project. If the founder(s) of the company have enough money from subsequent funding or actually have enough reserves in a "war chest" from sales/services/etc, they can actually buy out their partners if the partner is willing to take their offer.
      There are many different scenarios that come into play, but for the most part without a liquidity event in the form of going public and therefore gaining exposure to an extremely large investor population, it is more difficult to liquidate without an IPO than with. The IPO just allows for a vast array of investors to buy smaller (relatively) chunks of the company (making it more accessible) than say shopping around for a few investors with deep pockets (which would also take time/money that could be allocated to new business ventures, market research, legal work, etc.) They'd rather let the investment banks handle that ( - ). And like Sal says at around , even when an IPO occurs, all the initial investors are locked in for a mandated length of time to reduce volatility and a lot of other potential problems, so they can't cash out immediately once they go public. I'm no expert, so take what I say with a grain of salt, but I hope that helps and clears some confusion.
      (2 votes)
  • blobby green style avatar for user Monika Szablinska
    Hi Sal,
    Just one doubt - I can't find the answer anywhere else. Company can have more than 1 IPO? I mean does it refers just to the first time when the company goes public? What about relisted companies?
    (3 votes)
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    • male robot hal style avatar for user Andrew M
      Since the I stands for initial, you can only have one. Additional share sales by the same company at a later date are called follow-on offerings. They are often mistakenly referred to as secondary offerings, but that is not right. A secondary is an offering of stock by someone other than the original issuer.

      I am not sure what you mean by a relisted company. If a company gets bought out, and then years later it issues stock again, we would call that an IPO because there is no stock trading at the time of the offering. Think of that as a new company, because usually its share structure will be different on the second listing, and really only the name will be the same.
      (4 votes)
  • blobby green style avatar for user jazebel
    Are there videos on calculating IRR, NPV, NPR, etc? Am I missing something
    (3 votes)
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  • leaf green style avatar for user Jacob
    What exactly is the mechanism for "issuing" new shares? Does the board of directors simply decide, and then tell the investment bank? Who keeps a record of all this? How does ownership of a share pass from one person to another since their is nothing tangible?
    (3 votes)
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  • sneak peak green style avatar for user Ryan Nee
    At Sal talks about the difference between buying a stock from the market a long time after a company IPOs versus buying stock directly when a company IPOs. At he mentions that a certain chunk of money in buying an IPO goes to investment bankers. Does this mean that—all other things equal—it's to your advantage as an investor to buy an existing stock versus an stock that is going through an IPO? Or is that money (the 7%, in this case) paid by the company that is going public rather than investors? Who ultimately is paying the investment bank?
    (2 votes)
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  • blobby green style avatar for user ThomasMcGrath007
    why does "Sal" say "sure" at to the banks?
    Isn't that the whole companies/corporations choice?
    Wouldn't he have to talk to all the stockholders? Because he only own a small part of the company now. Or can the original idea makers choose what to do with the entire company/corporation?
    (2 votes)
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    • blobby green style avatar for user adeeb.qasem
      As per the scenario the company is running out of cash at this point, and an IPO will secure that at the same time the stockholders at also looking to be able to liquidate some of their shares! It seems to be work well for everybody: IB gets 7%, Company has cash to go on with its marketing and operations, Main owner and the VCs have the ability to liquidate!

      My question though, why would any company decide not to go for an IPO? (I will put this as a separate question)
      (2 votes)
  • leaf green style avatar for user Laszlo
    Why does the angel pay $ 5 M for a stake that is worth $ 5 M? To make a profit, wouldn't he want to pay either less then $ 5 M for a fifty percent stake in a $ 10 Mio company or pay $ 5 M but then get more than 50% to make a profit in the end? Or is he expecting that the company is actually worth more than $ 10 M? But then the post-money value is actually not a good representation of the value of the company.
    (0 votes)
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    • male robot hal style avatar for user Darren DeVore
      The angel would put $5M in as an investment believing that the future value of his ownership in the company would be greater than $5M. This is essentially the same as buying 1 share of a company for $50 with the expectation that the value of that share will go up in the future - just on a MUCH larger scale.
      (6 votes)
  • piceratops sapling style avatar for user beastmastery
    Hi Sal. Your lessons are great!

    Can you please do a video on why Facebook's IPO wasn't a success.

    Would love to hear other people's opinions too.

    Keep up the amazing work.
    vote ups
    (1 vote)
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Video transcript

In the last offer-- in the last video, not the last offering. I guess it was a bit of both. We had completed our Series B. We had gone back to the till. Got another round of venture capital funding. And we raised $10 million more that's going to help us build out the website and do some marketing, and hire up some more engineers and other employees. And to do that we had to sell one million shares. We essentially sold them at $10 a share. And so after that offering, well, our pre-money valuation was $30 million and our post-money is now $40 million. That's the value of our assets as-- I mean, the website, that's kind of an arbitrary valuation. And I've gotten a letter asking, well, how do you value that? And that's a whole subject for another playlist. And I will do that. I will do a whole playlist on valuation, eventually. But, to get there, the first thing to understand is just the capital structure and how capital markets work in general. So that's what we're doing here. But anyway, so after you got the $10 million-- you had $30 million before, you get $10 million, your post-money is $40 million. And we had to issue a million extra shares to do it. So before the money we had three million and now we have four million shares. So let me draw what our balance sheet looks like. So we had $1 million and then we raised $10 million more. So if we look at the left-hand side of our balance sheet, we have $11 million in cash, and we have our website and intellectual property. Maybe we have some patents now. So you can say assets of the firm. I guess you could say non-cash assets, right? That's cash. And some of them could be intangibles, like branding. Or maybe we made some small acquisitions of other people. And we'll do more videos on actually the mechanics of acquisitions and all that. But you get the idea. These are all of the other assets of the firm, whatever they may be. And then on the equity side, because we have no liability, so in this case assets will be equal to equity. On the equity side of the equation we just have four million shares. 1/4 went to the Series B guy, 1/4 went to the Series A guy. He had bought a million shares, I think it was at $7.50 a share. Then the angel investor had given us a million shares at, and I think it was $5 a share, that was the angel. And then there's me and my buddies, we split the last, that first million shares five ways. And if I wanted to draw my sliver, I still have my 200,000 shares. And we could keep doing that. We could get a Series C and a Series D that will keep us going. But let's say that a couple of other people have decided to sell socks on the internet. And we realize this is becoming a very competitive space. And we really want to just lay down the gauntlet. And make sure that ours is the dominant player. Because we figure that whoever gets the biggest market share fastest, is going to become the Amazon.com and everyone else is going to turn into these me-too players and they're all going to go out of business. So size has benefits in this situation. So we don't want to do these piddly $10 million offerings and $20 million offerings. We want to go big time. We say, you know what? We're going to expand our company huge, we're going to push marketing hard. And so we want to raise a lot of money. Let's say-- let me make up a number-- let's say we want to raise, I don't know, we want to raise $50 million. $50 million to invest in the business and do some hard-core marketing. And it happens to be at a time-- let's say it's 1999. The stock market is racing ahead. People would love to get in on this kind of stuff. So we say hey, let's do an initial public offering. And then that has two benefits. One, we will be able to raise a lot of money for the firm to invest in maybe building distribution centers or the marketing that I talked about. And the other side benefit, which we won't really talk about much at the board meeting, but all of these people right now, they're all holding these shares, right? I have these 200,000 shares. This angel investor has this million shares. And there's really not a lot they can do with them, right? Maybe the angel investor, maybe he had an expensive divorce settlement and he has to make some alimony payments now, and he doesn't really have the cash. He can't do anything with these shares, right? Same thing with these VCs. These VCs are accountable to their investors. And they can say-- like, this VC can say oh, you know what? I bought those shares at $7.50 per share, and then this guy came and bought it at $10 per share, so I already got a 33% gain on my investment. But the investors aren't that impressed by that, because you're still holding the shares. You can't really say they're worth $10 until you actually turned them into $10. Or you turn them into actual cash. So, by doing an initial public offering, all of a sudden all of the players will have liquidity. Which means they can exchange what they have, including myself. So they can exchange what they have for actual cash if they need to. So how does that work? So I would go to an investment bank, although they've all turned into commercial banks now. But we're talking in a pre-2008 world. I would go to an investment bank and I'd say-- or more likely they would come to me and say hey, you guys could raise big money in the public markets right now. Why don't you do an IPO? And in a few seconds you'll realize why they are so keen to do it. And I say, sure. We can raise a lot of money. And also we'll be in the press, so that'll be free marketing in and of itself. So I say sure, do all of the work. So what they'll do, is there will be a lead underwriter. Let me write that down, lead underwriter. And that's essentially the person who does all of the legal work. They're going to file documents with the SEC that describe the company. And they're going to make models and projections and all that. And then they're also going to have people riding along with them, other banks. And they're going to form a syndicate. A syndicate is just a group of banks that work together to kind of handle a larger transaction than any one of them would be willing to handle by themselves. And it kind of spreads the risk amongst them. So the bottom line is what the banks do, other than doing all the legal work. They'll value the company and then they'll go to all of their clients. So all of the people who trade through that bank, all of the institutional clients, all of the hedge funds that have their prime brokerage accounts at those banks. And just so you know, a prime brokerage account is just like a brokerage account, but it's a brokerage account for big guys. It's a brokerage account for people managing $100 million and not their E-Trade account. That's all a prime brokerage is. And they'll go to these guys and say hey, we have this hot IPO issue, socks.com. And we've done our models, and we think this is a $5 billion market. We think that this company is worth-- we think this company is worth at least $100 million in its current form. So once again realize, I mean, even though we're kind of doing something a little different now, all of the other things were essentially-- you could call them private offerings. Or private placements in some way. Essentially these were private equity sales. And I know that word is used a lot, private equity. And that's what venture capital essentially is. Although normally when people talk about private equity, they're not talking about venture capital. And I'll do a whole other video on that. But venture capital fundamentally is private equity, right? Because these shares that you're selling, they're not traded on a public exchange like the New York Stock Exchange or the NASDAQ, or something like that. So anyway, back to what we were doing. These guys, these banks, they go to their clients and say hey, I have this hot new issue. And they'll kind of gauge sentiment. They'll talk to clients, they'll talk to each other, and they say, oh you know what the demand is. And they'll essentially come up with some price, which is essentially as a high a price as-- they want do a high price because obviously as a company, I want to sell the stock for as much as possible. But they don't want to do it so high that the stock doesn't trade up. Most banks, you want your IPO to look like this. This is the first day of trading, this is your IPO price. They want it to look like that, so that in the future when there's an IPO, people get excited to get in it. If this IPO-- if the stock just did this, if it started collapsing, one, people will lose interest in IPOs in general. And then people will get suspicious about this company. And I'll do a whole video on that. So, how do the mechanics work? Well, they'll say, hey, you want to raise the $50 million, well you could do it a couple ways. We say hey, we're willing to issue another-- let me think of the best way to explain-- we're willing to issue another ten million shares, right? And I'm not drawing it proportionally. Let's say we're willing to issue another ten million shares, and this should be a lot higher, because this is four million right here. We're willing to issue a another ten million shares, how much money can we get for it? And let's see, these bankers talking to essentially the market, and talking to each other. They say hey, we think we can justify these guys, and we're going to do it for a little bit lower than they're actually worth. But we think the market will buy the fact that these guys are worth, I don't know, let's say they're worth $80 million in their current incarnation, right? Which essentially says, before we raise the money, we have $80 million, we have four million shares. So they're saying $20 a share. So if we go and issue another ten million shares at $20 a share, we'll actually raise $200 million. Actually, for the sake of-- so I don't have to edit my math-- let's say that's how much we wanted to raise, $200 million. So essentially what these guys will do, our board of directors will issue these new shares. And then this syndicate of banks, led by the lead underwriter will then sell it to their brokerage clients. To mainly institutional investors, but it might be some favored rich guys. If it's not that favored of an IPO, maybe you might get a call as well. And they'll sell it to all of them. And you say, why are they doing that? Why are they doing all of this work for the company, helping them raise $200 million? And they're going to the pain of the legal work, and they had to put a team of maybe ten guys on this. And they had to make models, and it probably took them maybe two or three months to do it. That's a lot of work, what do they get in exchange for all of this? Well they actually get a commission. And that commission, at least historically, has been 7% of the offering. 7% of the offering. And now you get a sense of why, in a good market, when you can do these things, why it has, in history, paid to be an investment banker. Because 7% of $200 million-- and frankly it's not a lot more work to do a $200 million offering than it is to do a $20 million offering, it's probably about the same amount. But 7% of $200 million is $14 million. So actually these guys aren't going to see $200 million. They're going to see 200 minus 14 million. So they're going to see $186 million. And then these bankers are going to split $14 million. And that probably is about two months of work for maybe ten guys. So you can imagine-- and of course they have the whole bank that has the support, and they have all these-- not anyone could do this. You have to have what they call retail distribution. You have to have kind of a channel that you can plug these shares into to actually get rid of the ten million shares. You see, it's a fairly profitable business. So that's what an initial public offering is. For the first time, a company is selling shares to the public, that is not just to these private investors. And usually on an initial public offering, although it's not always the case, these guys aren't selling their shares as much as they would like to. They're usually locked in for a certain period, just because it looks bad if, especially the insiders-- those were the founders of the company-- actually sell their shares. But six months later, then I can go and sell my shares. Maybe if I do it on a small amount, I can go and sell it in the NASDAQ. And I have a publicly traded price, so on any given day, I know exactly what my shares are worth. And this is an important thing to realize. Because a lot of times when people buy a stock they're like, oh, I've invested in that company. Well, kind of. When you normally buy a stock on an exchange, as the New York Stock Exchange, you're just buying the stock from somebody else. You're not buying the stock from that company. So when you pay $100 for an IBM stock-- I've run out of space, that's why I'm just talking and not drawing, let me erase this. I've run out of time, too. But I think this is an important point. When you buy stock from someone else-- so if I give my $100 and I get a stock certificate of IBM, most of the time, if I were to do this today, I'm just-- this is me, with a mustache-- I'm just getting it from some other dude, right? Well maybe he's happy because he got $100. He's got a top-hat. And this is what happens in the stock market every day. So when I buy that, I'm not really investing in IBM. I'm just buying the money-- I'm just buying that share from another guy. We're just exchanging shares. In an IPO, if I'm one of the IPO investors-- this is me-- my $100 in this situation-- let's see we're dealing with socks.com. Maybe that's it's ticker symbol, SOCK. This time it's actually going to the company. It's actually going to the-- or the website, in this case. Of course 7% is being re-directed to the investment bankers. So when you buying from and IPO you really are, to some degree, making an investment. Just like if you were doing a venture capital. You really are making an investment in a company. Your money will then be used by the company to hire people and build factories and make out a website and do marketing. In this case, you're essentially just trading shares in a secondary market. Secondary market just means that it's not going to the actual company. It's just going to another shareholder who bought it before you. Anyway, I've really gone over my time limit. So I'll see you in the next video.