Chris Haroun walks through how investment banks like Goldman Sachs set IPO prices using valuation methods like price-to-earnings and discounted cash flow, then typically discount the price by 30% to attract buyers. Banks gather demand from funds and investors across a price range before the final opening price is set based on supply and demand.
When going public, how does the company decide on its IPO price? Yeah, that's a great question. So what happens is this when a company goes public, they hire an investment bank, you know, like Goldman Sachs or Morgan Stanley or, you know, Barclays if it's overseas, or UBS or Credit Suisse if it's in Europe, etc. And what happens is the investment bankers, they'll do a lot of research and they'll look at similar companies to the one going public. And they will value the company going public based on the value of the comps compared to the similar companies. And if the company going public is growing faster than the competitors, then the investment banker will value that company at a big premium. Then once the investment banker values the company, and they usually use a couple different methodologies, they triangulate the process. They usually use price, earnings price to revenue, especially if it's not profitable, and then discount cash flow. And then they take the blended average target price of all three of those or other valuation methodologies. Then what they'll do is they'll then assign a discount, usually of about 30%. And the reason they do that is because you've got to entice people to buy the ipo. If the value of the company is priced for perfection, meaning it's fairly valued, no one's going to buy it. So you discount by about 30% or so. And then what happens is the investment bankers will get their trading floor and salespeople to sell the product, sell the product. And sometimes they set a valuation range. So they say the company should be valued between 10 and $14. And if the demand is white hot, like really, really high, then that stock will open above $14. Okay, if the demand is not that great, it will break the IPO price, which is really scary. And so when a company issues an S1, which is their IPO prospectus document, which you can get from SEC.gov when they do that, they don't know what the price is going to be because they don't know what the demand is going to be. And then the syndicate of investment banking firms work together and they take allocations demand from all the mutual funds. Mutual Fund 1 might say, I'll pay $12 for it, I'll take 10,000 shares. Mutual Fund 2 says now I'll pay $13 for it, but I'll buy 1,000 shares. Hedge Fund 4 or Hedge Fund 1 says, I'll take 3,000 shares. I and I'll value it at 14 bucks. So what happens is syndicate takes kind of a blended average of what the demand and supply is for shares to come up with how to price it. And then day one, usually around 10:00am New York time, if it's listed in America, then the bell is rung a little bit before then, but anyway, and the stock goes public that day. And if you have additional questions about the anatomy of an ipo, please let me know. Thanks.
