The Basics of IPOs

Q: When a company issues shares of itself in an initial public offering (IPO), how do the original owners of the company retain any ownership?

- B.P., Portland, Maine

A: When a company "goes public" with an IPO, it usually sells only part of itself. Here's a simplified example of how Scruffy's Chicken Shack (ticker: BUKBUK) might go public. Scruffy decides to sell 10 percent of his company to the public, via an IPO, in order to raise money for expansion. He currently owns all of the 90 million shares of the company and will sell 10 million new shares, so there will be 100 million shares after the offering. Investment bankers help Scruffy determine the valuation of the company and decide to price the offering at $20 per share, suggesting that the whole company is worth about $2 billion (100 million times $20). This means his company will collect about $200 million when the shares are sold (less the investment bank's fee of around 7 percent). Scruffy will retain ownership of 90 percent of the firm, or 90 million shares.

Q: Where can I learn about IPOs that are coming up?

- L.F., Modesto, Calif.

A: Consider steering clear, instead, as IPOs are notoriously volatile and frequently don't fare too well in their first year. Also, it's typically the rich or well-connected who get shares at their low initial price. Others end up buying later, often after prices have risen.

If you're curious, though, head to www.marketwatch.com/tools/ipo for a schedule of firms making their public debut. And for more on IPOs and why you might avoid them, head to www. fool.com and type "IPO" in our search box up top.

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