What is an IPO?
What You Need to Know
- An IPO is an Initial Public Offering, when a Private Company lists its shares on the stock market for the first time.
- Companies usually have an IPO to raise money to invest in an expansion of their business. They have become increasingly high profile and profitable in recent years, with 2014 seeing Chinese company Alibaba raise a World record US$21.8 billion from their IPO.
- IPO’s do also allow companies to access credit more easily, takeover or merge with other businesses and introduce schemes to attract the very best staff with share offerings.
- However having an IPO is not cheap with big legal and accountancy fees involved as well as the costs of joining a Stock Market.
- The IPO Process takes about a year and involves establishing a specialist team including Investment Bankers, gathering together all the relevant financial information, and selling the IPO to investors.
- As an individual investor it can be difficult to get involved in an IPO and it is often better to wait until the share price has stabilised to invest if you cannot get hares at the initial price.
What is an IPO?
An IPO is a commonly used acronym in business, and has increasingly reached the public consciousness through online businesses such as Facebook, Twitter, and Google. It stands for ‘Initial Public Offering’ and describes the first time that shares in a business are made available for the public to buy.
There are two different types of companies; public companies and private companies. Most businesses start out as private companies with relatively few people owning the company and its assets. As a private company, there is no obligation on the owners to release most information about the business, or to sell any part of the company to investors.
A publically held company is one which part or all of the business is publically available on a stock market. Shares can be bought and sold by institutional investors and private individuals, and the company is also subject to various rules and regulations regarding how they operate, and how they report their financial information.
Why do companies have IPO’s?
The main reason companies opt to have an IPO is to raise money. Depending on the size of the business and the interest there is in investing in it, an IPO can raise significant amounts of money.
The biggest IPO to date was for a Chinese business called Alibaba, which is in effect the Chinese version of Amazon, which raised US$21.8 billion through its IPO in 2014. Other notable IPO’s include Visa Inc. which raised US$17.8 billion in 2008, Facebook which raised US$16 billion in 2012, and General Motors, which raised US$15.7 billion in 2010, despite filing for bankruptcy just one year previously.
Obviously most business will raise more modest sums than this, but nevertheless an IPO is still a great way for a business to raise capital to reinvest in new ventures or expansion plans, and for existing shareholders to release some of the capital they hold in the business.
Are there other advantages to holding an IPO?
As well as raising capital, there are a number of other perks to holding an IPO.
- An IPO means a company faces increased scrutiny from both investors and regulators. This in turn means they can get better rates when they decide to issue debt or look to borrow money.
- New shares can continue to be issued as long as there is market demand for them. This makes it easier for the business to takeover another company, or to participate in a merger.
- Trading on the public markets increases a company’s liquidity and this in turn means that employee stock ownership programmes and other similar schemes can be introduced. This in turn will attract more talented people to join your business.
- Being listed on a Stock Exchange is also a big PR boost for a company and brings with it a considerable amount of prestige and boost your company’s profits.
- For investors, buying shares early in an IPO offers the opportunity to make quick money. It is quite common for new shares to go up in value when first listed, especially if the IPO has been hyped in advance. Early investors can therefore sell their stock for sizable profits fairly quickly.
Are there any disadvantages?
There are of course some disadvantages to an IPO as well. As someone who controlled a company, once that business is publically listed, you lose control as you have to answer to your shareholders. If the business loses money and the share price goes down, it is quite conceivable that the public shareholders could force you out of your own company in an effort to improve their investment.
Equally, for investors, there is often a 30 day limit issued on IPO’s, meaning you cannot sell your stock for the first thirty days. This can mean that you are unable to benefit from an initial price spike, as it is not uncommon for prices to go up and then drop back down again within that sort of timeframe.
How exactly does an IPO work?
The process of going through an IPO is a relatively complex one. It is not a quick process, and it can also be very expensive. As a way of making capital it is far from the most cost-effective in the short term, unless you can be confident of receiving sizable investment. Undertaking an IPO is not a decision a business comes to lightly, unless they are already of the scale of Facebook or Alibaba. The process works as follows:
- The company planning an IPO appoints a Project Manager and puts together an IPO team which will usually consist of lawyers, accountants, investment bankers and other financial experts.
- The team will start to collate all the necessary financial information about the business and also find ways to deal with any assets held by the company which are not profitable. At this stage the process of identifying a new management team or Board of Directors might take place if deemed necessary.
- About 9 months before the intended IPO, the company will put together a prospectus for potential investors with all the relevant details about the business including at least three years of financial figures.
- 6 month before the IPO, transition contracts will be agreed and financial statements are submitted for a full auditing process.
- 3 months prior to the IPO, the company will join the stock exchange it intends to be listed on, and the Board of Directors will meet for the first time. It is also at this point that prospectuses will be made available.
The expenses around an IPO go on legal and accountancy fees as well as the cost of listing on the stock market. Apart from initial fees, most of these costs will continue.
As an investor, should I get involved in an IPO?
As an individual investor it can be very difficult to access an IPO, and even if you can there are plenty of risks involved.
The main risk is of course that the value of shares can go up as well as down. Although it is common practice for companies issuing IPO’s to undervalue their shares a little to help encourage investors, it is not unknown for shares to be overvalued as well, so there is a risk of losing money as well as making it.
Then there is the fact that most IPO will be underwritten by an Investment Bank. This mean that they will assist with the IPO, by either buying the initial offering outright and then reselling it, or seeking to sell as much as they can. They will then make the IPO to their institutional investors first. As an individual investor you are the least important cog in the IPO machine as you will be investing a relatively small amount in the overall scheme of things.
Having an account with an Investment Bank is one way to get involved but these are only open to people with significant amounts of money who invest in stocks and shares on a large scale and on a regular basis.
In fact the likelihood is that if IPO shares are available to individual investors, it is most likely to be the type of IPO you won’t want to get involved with. The best approach to take is to wait until the IPO has launched and any cooling off period, where trading is restricted, has ended. Then the shares are publicly available to trade and will begin to reflect the real market value to the company.
Another key rule is to beware of buying into the hype. Everyone involved in an IPO is effectively a salesman looking to get the value of the shares as high as possible. Don’t fall for the sales patter but be sure to make your own assessment, or have an experienced broker make the assessment for you, and only get involved if you are sure the evidence suggests you re making a good buy.
- For more information on how to invest your money effectively take a look at our range of Investment Guides.
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- If you fancy dabbling in the stock market from the comfort of your own home, our guide to Buying and Selling Shares on the Internet has all the information you will need.
- Our glossary of common stock market terms helps the uninitiated get to grips with the stock market lingo.