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When a company starts off, 100% of shares are owned by cofounders. By the time a company is considering an IPO, the shares are owned like 70% by cofounders and 30% by options-holders like employees (I don't know - please, just go with the example).

So, when an IPO happens... Doesn't the company need to purchase the shares from the cofounders? But isn't that like selling to yourself?

Only after purchasing the shares from the cofounders, can the company sell its shares to the public in a secondary offering? Am I right? What is this first process called?

None of the articles about IPO cover this step. They assume that the company already owns its own shares. But this is not true, right? It's the confounders and option-holders that own it... right? It has to go from primary share holders -> company -> secondary share holders... Right?

Unfortunately, finance literature always assumes you understand some assumptions. Please clarify this detail, it will help a lot.

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  • Related: Why is stock dilution legal?
    – Ben Miller
    Jul 26, 2017 at 13:01
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    so the company creates shares for its employee option holders, but cant do the same thing for the general public?
    – CQM
    Jul 26, 2017 at 14:22
  • maybe you didn't notice, but why assume a double standard?
    – CQM
    Jul 26, 2017 at 14:34
  • the issue is preservation of value. How do the cofounders get commensurately compensated for creating a profitable company.
    – Calicoder
    Jul 27, 2017 at 16:41

1 Answer 1

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A company typically goes public in order to bring in additional capital.

In an IPO, the company (through its officials) will typically do so by issuing additional shares, and offering to sell those to investors. If they did not do that, then there would be no net capital gain for the company; if person A sells share in company C to person B, then company C does not benefit directly from the exchange. By issuing and selling additional shares, the total value of all stock in the company can increase. Being publicly traded also greatly increases the confidence in the valuation of the company, as a consequence of the perfect market theory.

There is nothing in this that says that initial investors (cofounders, employees, etc.) need to sell their shares in the process. They might choose to do so, or they might not; or they might be prevented from doing so by terms of any agreements that they have signed or by insider trading laws. Compare What happens to internal stock when a company goes public?

Depending on specifics, it might be reasonable for the company to perform a share split prior to the initial public offering. That, however, doesn't affect the total value of the shares, only the price per share.

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  • I was about to write a post talking about the (in)famous company that consists of $100 of gold but you beat me to it and covered basically everything I was going to +1 but :(
    – MD-Tech
    Jul 25, 2017 at 13:02
  • @MD-Tech there's nothing wrong with posting additional answers. A concrete example might actually be helpful to OP.
    – 0xFEE1DEAD
    Jul 25, 2017 at 13:44
  • @0xFEE1DEAD meh my answer would have been a bloated piece of ephemera compared with this masterful answer.
    – MD-Tech
    Jul 25, 2017 at 13:45
  • what's missing in your answer is how a company comes to be in possession of shares. For example: if person A has 100% of the shares in company C. Company C is worth $100. Then when C issues shares, person A now owns 80% of the company, worth $80. That's not fair! person A has lost money. Person A founded the company and worked so hard for it to get to this point, just to lose money because the board of directors realized they need more capital? How does C acquire its own shares from Person A? I don't believe C can just generate "shares" out of thin air. Can it? I mean how would that work.
    – Calicoder
    Jul 25, 2017 at 20:06
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    The company issues new shares and sells them to investors. Now it's worth $200 (the original $100, plus a new $100 that investors paid for the shares). But remember, before the IPO, there was no liquid market for the shares, so the value of Person A's shares was very hypothetical to begin with. She might agree to a valuation at the IPO that makes her shares worth only $80, because she thinks the company can use the new investor's money to increase the company's value until A's shares increase in value above $100 again.
    – The Photon
    Jul 26, 2017 at 2:24

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