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How IPOs Work

By Selena Maranjian – Updated Nov 15, 2016 at 5:05PM

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Typical IPOs are designed to shut out small investors.

When a company "goes public" with an IPO, it usually doesn't sell all of itself. For example, imagine the Bergen Bell Co. (ticker: RINGG), owned entirely by a woman named Adrienne. Adrienne decides to sell about 10% of the company to the public, via an IPO, to raise money for expansion. Adrienne, who currently owns all of the 90 million shares of the company, will sell 10 million new shares, so there will be 100 million shares after the offering.

Investment bankers help Adrienne determine the value of the company and how much of it she should sell, based on how much money she wants to raise. Let's say they decide to price the offering at $20 per share. This means that Adrienne's company will collect about $200 million when the shares are sold (less the investment bank's fee of roughly 7%). Adrienne will retain ownership of 90% of the firm, or 90 million shares.

This is often how the millionaires and billionaires you see in lists of the world's richest people become millionaires. Like Adrienne, most of their "wealth" is on paper and is tied to the number of shares they hold in their companies, multiplied by the current share price.

Search specialist Google's (NASDAQ:GOOG) IPO wasn't a typical one -- instead, it featured a "Dutch auction" process, like that used by Overstock.com (NASDAQ:OSTK) and RedEnvelope (NASDAQ:REDE). Learn all about IPOs and Dutch auctions in this Bill Mann article that preceded the IPO. Then read Bill's thoughts after Google's IPO.

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Longtime Fool contributor Selena Maranjian does not own shares of any companies mentioned in this article.

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Stocks Mentioned

Alphabet Inc. Stock Quote
Alphabet Inc.
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$101.42 (-0.01%) $0.01
Overstock.com Stock Quote
Overstock.com
OSTK
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RedEnvelope Inc. Stock Quote
RedEnvelope Inc.
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