What is an IPO?
An IPO, or Initial Public Offering, is when a private company will sell their stock to the public for the first time. This is when the ownership changes from being privately owned to become a public-owned company. Everyone can buy shares to become part of the owning class.
Why Do Companies Go Public?
- Capital raising: Any company expanding a business, new project, or type of debt repayment requires the raised funds through an IPO.
- Increased Visibility: A public listing enhances the visibility of the company. Significant employees, business partners, and customers are attracted.
- Ease of Liquidity for Founders and Early Investors: It enables founders and early investors to liquidate since their shares can be sold to facilitate liquidity.
The IPO Process
- Strategic Planning: Companies draw strategies for growth and market conditions before opting for an IPO.
- Underwriters: Investment banks are hired for the process of an IPO to provide pricing and marketing.
Creation of Prospectus: A detailed document explaining the business model of the company, financial status, and risks that may affect it to the best ability of the investor.
SEC Filing: In the U.S., the company files S-1 Registration with the SEC, detailing the IPO.
Roadshow: The company will advertise its business to potential investors before the IPO to create interest.
Pricing: The price of the stock will be determined by the demand and conditions in the market. - Trading and Distribution: Once the shares have been distributed, the company will be traded on NYSE or Nasdaq, etc.
IPO Important Terms
- Underwriting: Investment banks purchase shares from the issuing company and then sell them to the public.
Prospectus: This is a statement of the company and an offer from an IPO
Greenshoe Option: It provides underwriters with an opportunity to sell extra shares due to higher-than-expected demand.
Lock-Up Period: Number of days, usually 90-180 days, for which insiders cannot sell their shares.
Advantages to Investors
- Potential for Huge Profits: The initial investors will be capable of earning huge profits if the company performs well.
- Diversification: IPOs offer an avenue to diversify a portfolio by including new equities.
Risks with IPO
Volatility: IPO stocks are known to record large price changes after their listing.
Overvaluation: High prices due to hype surrounding an IPO, which tend to crash later.
Less Historical Performance: Less history of performance for the investors to study in the case of an IPO.
Examples from the Real World
Tech IPOs: Uber, Lyft -This explains what big tech IPOs do to the market
Performance Analysis: Scavenge for history in previous ones as a way of learning about what happens with an IPO after listing.
IPOs can be thought of as a prime source of investment if investors look to gain where growth and returns are sound. However, an IPO is far from risk-free; therefore, any investment made in an IPO should be based on deep research and strong consultation.
