An initial public offering (IPO) refers to the process of offering shares of a private corporation to the public in a new stock issuance for the first time. An IPO allows a company to raise equity capital from public investors, realizing the full profit from their private investment. What is an IPO?
How an Initial Public Offering (IPO) Works
Before an IPO, a company is considered private.
- When a company reaches a stage in its growth process where it believes it is mature enough for the rigors of SEC regulations along with the benefits and responsibilities to public shareholders, it will begin to advertise its interest in going public.
Advantages and disadvantages of an IPO
Access to investment from the public
- Easier acquisition deals
- Increased transparency with required quarterly reporting
- Fluctuations in a company’s share price can be a distraction for management
- The company becomes required to disclose financial, accounting, tax, and other business information
Investing in an IPO
When a company decides to raise money via an IPO it is only after careful consideration and analysis that this particular exit strategy will maximize the returns of early investors and raise the most capital for the business.
- The price of the IPO is set by the underwriters through their pre-marketing process
- IPO price is based on the valuation of the company using fundamental techniques
- Discounted cash flow: net present value of expected future cash flows
- Equity value: equity value, enterprise value, comparable firm adjustments
- Underwriters factor in demand and discount the price to ensure success on IPO day
Purpose of an Initial Public Offering
IPO is a fundraising method used by large companies
History of IPOs
The term initial public offering (IPO) has been a buzzword on Wall Street and among investors for decades
- Since the Dutch are credited with conducting the first modern IPO, IPOs have been used as a way for companies to raise capital from public investors through the issuance of public share ownership
- IPOs are known for uptrends and downtrends in issuance due to innovation and various other economic factors
- Tech IPOs multiplied during the dotcom boom as startups without revenues rushed to list themselves on the stock market
- After the 2008 financial crisis there were few new IPOs due to the downturn
Can anybody invest in an IPO?
There is no guarantee that all investors will be able to purchase shares, but there are several ways to participate
What Is the IPO Process?
There are two parts to an IPO: pre-marketing and initial public offering.
- The IPO process consists of two parts: the premarketing phase of the offering and the IPO itself, which includes soliciting bids and public statements to generate interest, and the underwriters, a team consisting of lawyers, public accountants, and Securities and Exchange Commission (SEC) experts that manage different parts of the IPO process collaboratively.
Tracking IPO Stocks
When an existing company spins off a part of the business as its standalone entity, creating tracking stocks
- Provides investors with a lot of information about the parent company and its stake in the divesting company
- IPOs are known for having volatile initial day returns that can attract investors looking to benefit from the discounts
Is an IPO a Good Investment?
IPOs are popular among investors because they tend to produce volatile price movements on the day of the IPO and shortly thereafter.
How Is an IPO Priced?
The value of the company is established by the company’s fundamentals and growth prospects.
IPO Alternatives
Direct Listing
Performance of IPOs
Several factors may affect the return from an IPO which is often closely watched by investors
Lock-Up
When a company goes public, underwriters make company insiders, such as officials and employees, sign a lock-up agreement.
- Lock-up agreements are legally binding contracts between the underwriters and insiders of the company, prohibiting them from selling any shares of stock for a specified period. The period can range anywhere from three to 24 months.
