What does Initial Public Offering (IPO) mean?
An Initial Public Offering (IPO) is when a company lists its shares on a stock market for the first time. This allows anyone with access to a stock trading app to invest in a company at the click of a button.
Over the years IPOs have been gaining more interest from the everyday investor, who want to get an early investment in what could potentially be a great growth opportunity.
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What does going public mean?
The term “going public” refers to a change in how the company will be owned – anyone can invest in the company on a marketplace accessible to the public. By this way, public companies help to democratise the investing world by allowing you to invest in companies across the world with relatively small amounts of money.
Public v private limited company
Every single stock market giant started of life as a humble private company.
A common starting point for most businesses is as a private limited liability company – this company structure can be spotted by the incorporated (Inc.) or limited (ltd.) often placed at the end of company names.
A private company has a group of owners (generally a handful of founders) who are able to wield ultimate control on the company.
A public company can have hundreds of thousands of owners, typically having a vote at the AGM and a share of the profits in the form of a dividend. Due to the nature of public companies, they are subject to far more stringent regulations which can make them far more appealing to all investors.
The purpose of an Initial Public Offering
By way of an IPO, a private company goes from a small group of owners to a large group of shareholders who are able to exchange said ownership rapidly over an exchange such as the New York Stock Exchange (NYSE) or NASDAQ.
An IPO allows smaller investors a level playing field with the large institutions by getting in on the ground floor of a business, with the freedom to sell a part or all of their stake in the future with relative ease.
Process of Initial Public Offering
In order for a company to go public they will require an underwriter which usually takes the form of an investment bank – occasionally a group of banks will form a syndicate for the same purpose.
A syndicate is usually formed when an IPO is too big for one bank to handle, and allows for a greater pool of resources.
Before an IPO is launched, it needs a launch price. The underwriter helps in setting this IPO price by way of a roadshow – making presentations to large clients such as funds and investment bankers.
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This can be analogised as a form of market research and sales for investment bankers – but the “product” is not the goods sold by the company, but rather the company itself. The investment banker may not have an appetite for a McDonald’s hamburger, but they may well be interested in owning McDonalds.
On this roadshow the underwriter is able to assess the level of interest in that particular IPO and price the shares in line with that level of interest.
After gaining an idea of who is actually interested in investing the underwriter will guarantee the price and number of shares to be sold – getting a good estimate of the interest is critical, as any shares that are leftover is bought by the underwriter.
Is buying an IPO a good idea?
As with all investments risk is relative, although an IPO is typically considered more of a risk than a company that has been publically listed for some time. Because of the nature of going public, getting the launch price right is notoriously difficult and many people joke that the real meaning of IPO is “It’s Probably Overpriced”.
It is not uncommon to see a stock launch and rapidly see its share price drop. For this reason, new investors are generally discouraged from buying IPOs unless they are confident in the company and willing to stomach wild swings in share price during the early days.
This article is not advice and has not been prepared in accordance with legal requirements designed to promote the independence of investment research – no recommendations are given in the buying, selling or holding of any investments. Past performance is not a guide to the future. Investments rise and fall in value so investors could make a loss. Always seek professional advice.