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What Is an IPO?

Joshua Morris -

An IPO, or Initial Public Offering, means that the company ownership is changing from being private to being public. It happens when a privately owned company lists its shares on a stock exchange and thus makes them available for purchase by the public.

How an IPO Works

Going public is not an easy process. Companies need not only to prepare for the challenges associated with being public but to have a lot of paperwork done to complete the process. Along with it, they have to make a lot of financial disclosures to comply with all requirements of the Securities and Exchange Commission (SEC) which oversees public companies.

These are the main reasons why a company that is going to go public doesn’t do it alone. It hires an underwriter - normally, an investment bank, to consult on all the processes and to assist in setting the offering price.

The underwriter also creates the main documents for investors and schedules meetings.

Why Do an IPO?

Both startups and companies that have been in business for decades can opt for an IPO. Normally, an IPO is done to raise funds for paying debts, to get funds for a new project or a new development direction, to allow the company shareholders to diversify their investment portfolio, or to create some liquidity by selling a part or all of the private shares in an IPO.

Future IPOs

The most promising upcoming IPOs are the following.

How to Buy IPOs

Even though the process is called Initial Public Offering, buying shares is not as simple as one can imagine. To buy an IPO, one has to deal with a brokerage that handles the IPOs, and not all brokerages offer that service.

Some brokerages will ask you to meet certain requirements such as:

  • a minimum balance on your account
  • a certain number of traders (or trades made for a certain sum)

Even if you meet these requirements, you may not be able to participate in an IPO from the very start. And when you finally can buy shares, their price may grow significantly. For example, by the time the shares are available to the general public, they may cost $70 while their initial price was $20.

Where Can One Buy IPO?

You cannot just buy an IPO on a stock exchange. To get shares offered within an IPO, you need to find a broker that offers this service. TD Ameritrade, Fidelity, and Charles Schwab are one of the best such brokers.

Should You Invest in IPOs?

Investing in an IPO can end up with significant benefits but is also risky. It is actually much riskier than investing in an established company. Less data is available about a company going IPO, and thus, investors cannot rely on loads of info like it is the case with established businesses.

The fact that the company goes public doesn’t mean your investment will be successful. Take some examples:

  • Lyft, a competitor of Uber, went public with an initial price of $78.29 per share. But one year later, one share was traded at $21. Now, one share is approx. $57. So, investors still haven’t recovered their money.
  • Peloton opened the IPO at slightly over $25 per share and the share value dropped to $17 over several months. However, in 2021, the share value surged to over $150.

So, buying an IPO is not actually investing but rather speculating. And data on IPO profit shows that benefits generated through an IPO differ from one year to the next.

Source: Bloomberg Finance

Key Differences Between IPO and ICO

In the crypto world, an Initial Coin Offering (ICO) is used instead of an IPO. It constitutes selling coins to the general public. However, only those coins can be sold in an ICO that back a share in the organization’s equity. In such a case, the company’s shares are placed in digital tokens.

Advantages and Disadvantages of an IPO

Any IPO comes with its benefits and drawbacks.

Advantages:

  • For the company, an IPO means getting access to wide funding opportunities which, in turn, enables raising funds easier and faster.
  • It increases the company’s prestige and boosts the brand awareness
  • It surges the company’s transparency because of a need to file quarterly reports.

However, there are some drawbacks, too.

  • Going IPO is expensive and often involves hiring a third party to help manage all the document flow
  • Share prices fluctuate which creates additional pressure on both company’s management and investors

FAQ

Yes, an IPO is absolutely legal.

What are IPO Alternatives?

There are the following IPO alternatives.

Direct listing - it is the same IPO but conducted without underwriters. It lowers the costs but increases the risks.

Dutch auction - it is also an IPO but the initial share prices are not set. Potential investors bid on the shares they want to buy and indicate the price they are willing to pay.

Can anybody invest in an IPO?

Normally, there are limitations on who can invest in an IPO. So, you may be asked to confirm that you have the needed balance in your account, and/or that you have performed a specific number of trades for a required sum within a specified timeframe.

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