Where Stocks Come From

If you’ve ever wondered where stocks come from, here’s an explanation: Imagine the Home Surgery Kits Co., which aims to offer operations that can be performed in the comfort of your home. It will start small, but to grow, it will need to hire more employees and buy more equipment. For that, it needs cash.

Home Surgery Kits can get that cash in several ways. It can borrow money from a bank. It can issue bonds, which involves borrowing money from individuals or institutions and promising to pay them back with interest. It can find some wealthy people or companies interested in investing in the new homesurgery industry. Or it can “go public” via an initial public offering (IPO), issuing shares of stock.

To go public, it will need to hire an investment bank, which underwrites stock and bond offerings. The bankers will study Home Surgery Kits’ business. If they think the company is worth, say, around $300 million, they might recommend (based on the company’s needs) that it sell 10 percent of its business as stock, issuing 1 million shares priced at $30 per share. Once it’s announced that the company is going public, if people are scrambling to buy shares, the bank might increase the opening price, while a lack of interest could cause the price to be lowered — or Home Surgery Kits might even postpone or cancel the offering.

If all goes as planned, $30 million will be generated. The investment bank will typically keep about 7 percent, a hefty sum, for its services, and Home Surgery Kits will get the rest. From now on, people will buy and sell Home Surgery Kits (ticker: OUCHH) shares from one another on the market, typically through brokerages. Home Surgery Kits will not receive any more proceeds from these shares — it got its money when it issued them.

As a public company now, Home Surgery Kits will have obligations to its shareholders and the Securities and Exchange Commission (SEC). For example, it will have to report earnings quarterly and have its reports regularly audited.