Lesson A6.1 · 1 of 5 · Special situations
How an IPO works: the steps, pricing, allocation and long-run returns
An IPO is a company’s first public sale of shares: a prospectus, a bookbuilding period with a price range, a final price, allocation, and then trading on the exchange. US IPOs rose 19% on average on their first day (1980-2025), yet over three years they lagged the market.
Terms in this lesson
- IPO
- The moment a company sells its shares on the stock exchange for the first time.
- Market cap
- What the company is worth on the stock market: price times number of shares.
- Free float
- The part of a company's shares that trades freely on the market.
The steps of an IPO: prospectus, bookbuilding and pricing
The Beginner lesson on stock exchanges explains why, when you buy a share, your money goes to another investor rather than to the company. An IPO (initial public offering) is the rare moment when someone sells shares directly to investors: the company, if it issues new shares, or existing shareholders, if they sell part of their stake.
Definition
The stages of an initial public offering
Prospectus, order book, price, allocation, then trading.
The banks running the deal (the underwriters) help the company prepare the prospectus and set the price. The SEC says the company and the underwriters decide together where the offer price is set.
- ProspectusThe official offer document: the business, the numbers, the risks, who is selling and how much.
- BookbuildingThe underwriters collect orders from investors within a published price range.
- Final priceSet according to demand, usually inside the range.
- AllocationShares are handed out; if demand is high, everyone gets only part.
- Lock-upSellers and management agree not to sell for a while, typically 180 days.
According to the SEC, underwriters distribute most IPO shares to their institutional and high-net-worth clients. The lock-up terms are disclosed in the prospectus; ahead of the expiry, the share price may fall if the market expects the released shares to be sold.
The rest of this lesson is in the subscription
The subscription unlocks every chapter of Intermediate, Trading school, Investor psychology and Advanced, with their exercises and unlimited reviews.
Create a free accountThe Hidroelectrica IPO of 2023: price, proceeds and allocation
Hidroelectrica, Romania’s state-controlled hydropower producer, began trading on 12 July 2023 under the symbol H2O, with a market value of 46.77bn lei (€9.45bn) at the offer price. The Bucharest Stock Exchange called it the largest IPO in its history. Fondul Proprietatea, a listed fund, sold 89.7 million shares, its entire stake. Institutions received 80% of the shares and retail investors 20%. Retail investors who applied in the first five business days got a 3% discount, paying 100.88 lei a share, which is why the total is slightly below 104 × 89.7 million.
Why IPOs jump on day one: underpricing
Jay Ritter of the University of Florida has kept statistics on US IPOs for decades. In his tables updated on 5 October 2026, the 9,345 IPOs of 1980-2025 rose by an average of 19.0% on their first day, from the offer price to the first close. The sample excludes offers priced below $5, ADRs, SPACs, closed-end funds and a few other categories.
Average first-day return on US IPOs, according to Jay Ritter: 7.2% in 1980-1989, 14.8% in 1990-1998, 64.6% in 1999-2000 and 19.1% in 2001-2025. The average over the whole 1980-2025 period is 19.0%.
For the sellers, the first-day pop is a cost: Ritter puts the “money left on the table” in 1980-2025 at $250.1bn, against total proceeds of about $1,200bn. In other words, the shares could have been sold for more.
Long-run IPO returns and what to read in a prospectus
Also according to Ritter, buying the 9,253 IPOs of 1980-2024 at their first close and holding for three years returned 19.1% on average, including dividends. Over the same periods, the US market (the CRSP value-weighted index) returned 39.6%. Against listed firms of the same size and book-to-market ratio, the shortfall was 8.9 points.
- Who is selling and where the money goes: new shares for the company, or existing shares for current owners.
- Risk factors: the section most people skip, though it is where the company names its own weak points.
- Two to three years of accounts: sales growth, profit, debt.
- Ownership after the offer: who controls the company and what rights minority shareholders have.
- The lock-up: who is locked up, for how long, with what exceptions.
- Dividend policy and any related-party transactions (see the lesson on them).
Lessons are educational. They are not a recommendation to buy or sell. Investing involves risk and you can lose money. Sources: Jay R. Ritter, “Initial Public Offerings: Updated Statistics” (Tables 1 and 1a) and “Initial Public Offerings: Updated Long-run Statistics” (Tables 16a and 19), University of Florida, 5 October 2026; Bucharest Stock Exchange, press release of 12 July 2023 on Hidroelectrica’s debut; the final price and allocation announcement (Economedia, 5 July 2023); Reuters, 5 July 2023 (the 94-112 lei price range); SEC, “Investor Bulletin: Investing in an IPO”; Investor.gov glossary, “Initial Public Offerings: Lockup Agreements”; our own calculations.