What is an IPO and how does one work?
Can you buy shares in a company before it’s listed on the stock market? Is it a good idea to buy shares in companies that are untested on the stock market? This guide to Initial Public Offerings (IPOs) will explain how it’s possible to buy shares before they’re listed and whether or not it’s a good idea.
What is an IPO?
IPO stands for Initial Public Offering, which is a term used to describe the process private companies go through to raise funds through a stock market listing. In other words, an IPO is where a private company offers shares to the public. Crucially, this is a new stock issuance and it’s the first time that shares have been offered to the public.
In practice, private companies that have a share structure are known as pre-IPO. That means the company has raised capital through private funding. Once this company gets to a point where offering new shares to the public could be beneficial, an IPO takes place. This Initial Public Offering gives outside investors the chance to own a piece of the company. This takes it from a privately funded entity to a public company.
Why do companies go public?
IPOs, as we know them today, can be traced back to 1602 and the Dutch East India Co. Although it wasn’t referred to as an Initial Public Offering of shares, this company offered equity in its trading business. Since then, IPOs have become the standard way for private companies to raise capital. However, each Initial Public Offering of shares will take place for individual reasons. Raising capital is the main reason, but others are:
- To fund a company’s expansion plans
- To pay off debts/offset debt
- To monetise assets
- To raise the company’s profile through a stock market listing
- To attract new customers and/or employees through increased publicity
How does a company go from private to IPO?
How does a private company go public and have its share price listed on the stock market? As you’d expect, the process is somewhat complex and can’t be done without the help of accountants, lawyers and financial regulators.
A pre-IPO company will have been funded by private investors. These investors own a share of the company. This is important because the original shareholders may either retain a specially ring-fenced stake in the company after the IPO. Alternatively, they may sell their shares before the company is listed, something that essentially creates a blank slate.
Once the company’s executives decide they want to go public, they have to open up their books to a stock exchange’s financial regulator. The regulator reviews the financial reports submitted and decides whether the company’s accounts, business practices, and reputation are good enough for it to be listed on the exchange.
The initial public offering of shares
When the company has received regulatory approval and accounts have helped set up a new share structure, a listing is created. People are then able to view the company’s IPO prospectus and decide whether or not it’s a worthwhile investment. Within the prospectus will be details of the company’s financial position, its intended IPO share price, its share price projections, and its future plans.
Investors that deem the opening share price worthy of an investment, based on the prospectus, can pay the asking price. There will be a pre-set number of shares available to the public. It will also be clear which shares are owned by existing investors, how shares in the company relate to voting rights and whether public shareholders are entitled to dividends.
An Initial Public Offering will run for a set period of time or until a financial target/share target is hit. Once the IPO has finished, the company will be listed on the stock market and have a public share price. This share price reflects the performance of the company and it’s the amount investors can buy or sell at.
Pros and cons: investing in an IPO vs. existing shares
Our site contains details of upcoming IPO listings, as well as companies that are already public. Investing in IPOs and shares can be profitable. However, both can also be risky and leave you with a loss.
The question, therefore, is which option is right for you. Are upcoming IPO listings the right thing for you to focus on? Or, should you invest in shares CFDs in companies already listed on the stock market? To help you decide, here are some pros and cons:
- The share price during an IPO may be the cheapest it will ever be for that company
- Existing shares have a price history that you can analyse
- IPO hype can help a company’s share price increase quickly, which could give you a quick profit
- Public companies are often more reliable as they’ve been in the spotlight for long periods of time
- Not a lot of people know about IPOs, so you can often get a good deal
- The company you’re investing in during an IPO may be fairly new and will be an unknown quantity in the financial markets
- Existing shares might be expensive and have little room to grow significantly
- Some IPOs start with too much hype and the initial share price is too high
- Being a publicly listed company isn’t always a mark of quality
- Upcoming IPO listings aren’t always easy to find
IPO case studies: companies that went public
Private companies are launching IPOs all the time. Some are successful, others aren’t. Below are two examples of private companies that went through Initial Public Offerings.
Monday.com Ltd IPO
This systems software company launched its IPO in 2021. It has 17 hedge fund holders, and its initial share price was $173.15, and it quickly jumped to $182. That was 17% higher than its IPO price of $155 per share. From the 3.7 million shares sold at $155, the company raised $574 million and, based on its subsequent stock market performance, the IPO was a success.
The Uber IPO was one of the biggest in 2019. The taxi and delivery company had grown into an international brand and its entrance onto the stock market was supposed to be a huge success. Uber priced its shares at $45 for the IPO but, after the first day of trading, they fell 7.6% to $42. At the time of writing, the Uber share price was $36, demonstrating that not all IPO share prices are a bargain.
More resources: invest in IPOs online or not?
That’s the basics of IPOs, some pros and cons, and the mixed fortunes investors can have. If you’re willing to accept the risks that come with investing via IPOs, you need to go beyond the basics. This means looking through the upcoming IPO listings and using our market insights to learn more about the companies going public.
You should first understand what a company does and why it could be profitable. Of course, if buying shares via IPOs isn’t for you, there are plenty of other instruments you can trade, including forex. However, if you like the idea of investing in a company before it becomes a stock market stalwart, make sure you check out the latest IPOs.
Not investment advice. Past performance does not guarantee or predict future performance.
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