What Happens to Private Stocks During an IPO?

When a privately-held company with equity backers enters the publicly traded financial markets, the private shares can be treated in a number of different ways. The private backers could sell of the equity shares alongside the company in the debut offering. These investors might decide to release a portion of the private shares owned and sell the remainder of holdings in the future. There may be certain restrictions on the manner in which private stock can be released in the public markets.

Corporate executives, private equity firms and other financial backers might own shares of a company before the business becomes publicly traded. Private equity companies in particular are in the business of obtaining majority ownership in a company, improving the operations of that business and subsequently selling the stake for a profit. One key way that private equity firms begin to capitalize on an investment is to sell private shares into the public markets during an initial public offering, according to a 2011 article on the CNN Money website.

Holders of private shares may decide to do absolutely nothing with the shares when a business enters the public market. In 2006, when Hertz Global Holdings held its IPO, the company sold its own equity. Several private backers opted to maintain their stakes instead of participating in the windfall that an IPO often brings. Private investors were recipients of a $1 billion payout in the form of a dividend prior to the IPO, however, according to the CNN Money article.

Private financial backers are often able to acquire large stakes in a business at a discount in exchange for financing operations or an expansion. When a private company becomes public, holders of private stock may not be permitted to sell shares for a period of months. This lock-up rule is enforced at the discretion of the underwriters in a new offering. The restriction exists to prevent abnormal trading activity from occurring in a new stock.

The details surrounding an IPO are disclosed in a company's prospectus, which is filed before the deal occurs. Some of the financial information available in the document includes the anticipated price range for the public shares and the number of equity shares available. The prospectus discloses the source of those shares, whether it be from the company or outside investors. If there is an alarmingly high number of IPO shares being sold by private investors, the company's profits from the deal diminish. Instead, private investors selling stock to public investors reap the profit from the sale.