What is an IPO (Initial Public Offering)?

What is an IPO (Initial Public Offering)?

An IPO or Initial Public Offering is the process of listing a private company in a stock exchange, making its shares available to be purchased publicly. Before the IPO, the company shares are privately held by the founders, angel investors, vc firms and early teams or employees.

An IPO is a way to raise money from public investors for the business. It allows private shareholders to cash in and earn the returns of their investment. Private investors may opt to hold onto their shares, sell a portion or all of their shares.

How does an IPO work?

Moving from a private to a public company is a challenging yet time-consuming process. There is a ton of paperwork to prepare and a lot of financial statements to meet the requirements of the SEC (Securities and Exchange Commission).

That’s why hiring an underwriter is part of the plan. The private company simply can’t navigate alone. Underwriters, usually an investment bank, help managing the IPO process such as putting together key documents, scheduling meetings and preparing other potential requirements.

Once the initial price is set for the IPO, the underwriters will issue shares to investors and the company starts trading its stock on a public stock exchange such as Nasdaq, NYSE (New York Stock Exchange) or HKEX (Hong Kong Stock Exchange).

Why do companies go public?

Generally, the purpose of an IPO is to bring cash into the company. But, it may not be the only reasons. There is a number of purposes why companies apply for the IPO.

  1. To let early investors cash out their investment. It’s common when early investors want to sell their shares, either some or all of them due to several reasons.
  2. To raise additional capital for business. Could be used to fund business expansion, product research and development or to pay off existing debt.
  3. An alternative to raise capital instead of bringing in venture capitalists or bank loans, which can be expensive.
  4. Going public brings huge publicity, which create trust to help companies secure better terms in business and financial dealings.

Going public in an IPO may be a better option to raise capital but it also complicates a number of matters. There are more reports to file quarterly and annually, more challenge in answering to shareholders and other reports to prepare.

Should you buy an IPO stocks?

Since the underwriters are getting people excited about the IPO as well, there will be a lot of buzz going on. You may be interested to make immediate purchase but do consider some following.

It could be a relatively new startup or a company that has been around for a while but not profitable yet. And there’s a probability, the valuation is being set too high.

If you remember or know about the dot-com bubble, also known as the internet bubble in the late 90s, you may want to be extra careful in investing on an IPO. During the period of 1998 – 2000, many investments were burned by new, even big in scale but unprofitable internet companies. They crashed in the stock markets when went public.

Can anyone buy stocks on the IPO?

Usually, the demand in purchasing stocks on the IPO is bigger than the supply. That is why, the opportunity to buy shares in an IPO is not as easy. However, here are two options you can do to invest.

  1. Purchase through a broker, but be noted that sometimes, access to the shares can be limited to the brokerage firm’s bigger accounts only.
  2. Purchase through a mutual fund or other firms and platforms that focuses on the IPOs.

To conclude

Though investing on an IPO is exciting, but it’s risky as well. Make sure to do your homework surrounding the companies before making the decision and be wary of overvalued stocks which could happen on the initial public offering.

Beside the risks, there’s also a chance the business grows. When the time comes, investing in an IPO could leave you with a handsome reward in future. This may take several years but it’s worth the wait.

Do you have anything to share regarding the IPO? Let’s write your thoughts in the comment box below.

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