An IPO (initial public offering) is the process of selling shares of a private corporation to the general public in the form of new stock issuance. A company can raise capital from public investors by issuing public shares. The transition from a private to a public company can be a critical time for private investors to fully realize the benefits of their investment because it typically includes share premiums for current private investors. Meanwhile, public investors are permitted to engage in the offering.
What are the main features of an IPO?
- IPO is the process of selling shares of a private corporation to the general public in the form of a new stock issuance
- To hold an initial public offering, companies must meet the requirements of the Securities and Exchange Commission (SEC)
- IPOs give companies the opportunity to raise capital by selling shares on the stock exchange.
- Companies hire investment banks to market, assess demand, and establish IPO prices and dates, among other things.
- An IPO can be perceived as an exit strategy for the founders of the company and early investors, allowing them to realize the full value of their private investment.
Are IPOs solid investment opportunities?
Many people think of IPOs as big money-making opportunities—when high-profile companies go public, they make headlines with massive share price gains. While IPOs are unquestionably trendy, you should be aware that they are extremely risky investments with inconsistent long-term returns.
How does an Initial Public Offering work?
Going public is a difficult, time-consuming process that most businesses find hard to handle on their own. A private company scheduling an IPO must not only plan for an increase in public oversight but also file plenty of paperwork and financial disclosures to satisfy the Securities and Exchange Commission (SEC), which regulates public companies.
That is why a private company that intends to go public hires an underwriter, usually an investment bank, to advise on the IPO and assist in determining the initial offering price. The underwriters assist management in preparing for an IPO by creating key documents for investors and scheduling venue meetings with potential investors.
Once the company and its advisors have agreed on an IPO price, the underwriter distributes shares to investors and the company’s stock begins trading on a public stock exchange, such as the New York Stock Exchange (NYSE) or the Nasdaq.
Why do companies issue IPOs?
An IPO may be the first time the general public can buy shares in a company, but it’s helpful to clarify that one of the goals of an IPO is to allow early investors in the company to cash out their investments.
Consider an IPO to be the end of one stage in a company’s life cycle and the start of another—many of the original investors want to sell their investments in a new venture or start-up. Alternatively, investors in more defined private companies that go public may want to sell some or all of their shares.
Other reasons for a company to pursue an IPO include raising capital or increasing a company’s public profile:
- Companies can raise additional cash by issuing stock to the general public. The revenues could be used to expand the business, fund R&D, or pay off debt.
- Other methods of raising capital, such as venture capitalists, private investors, or bank loans, may be prohibitively expensive.
- Going public through an IPO can provide companies with a lot of publicity.
- Companies may prefer the position and credibility that come with being a publicly traded company, which may also help them secure better terms from creditors.
While going public could make it easier or less expensive for a company to raise capital, it complicates plenty of other issues. Privacy rules include filing quarterly and annual financial reports. They must respond to shareholders, and there are compliance mechanisms for actions such as stock trading by senior executives or other transactions such as selling assets or considering acquisitions.
The IPO terms that we need to understand
- Common stocks – ownership units in a public company that usually entitle stockholders to vote on company matters and receive dividends.
- Issue Price – the price at which shares of common stock will be sold to investors before an IPO company begins trading on stock markets. Popularly known as the asking price.
- Lot size – the smallest number of shares that can be purchased in an IPO. You must bid in multiples of the lot size if you want to buy more shares.
- Preliminary prospectus – the IPO company’s document that discloses information about its business, strategy, historical financial statements, recent financial results, and management.
- Price band – the price range for IPO shares set by the company and the underwriter. It differs depending on the type of investor. Qualified institutional buyers, for example, may have a different price range than retail investors.
- Underwriter – the investment bank in charge of managing the offering on behalf of the issuing company. In general, the underwriter determines the issue price, publicizes the IPO, and assigns shares to investors.
How can we find out about future IPOs?
In 2020, there were more IPOs than in 16 of the previous 20 years, indicating a significant increase in IPO activity. Similarly, 2021 promises plenty of highly anticipated initial public offerings.
If you want to find out about the upcoming IPOs check out the MarketWatch IPO Calendar and the FreeTrade’s list.
