What Is An IPO?

IPO, sounds a bit pompous doesn’t it? It stands for “Initial Public Offering”. It is where a company sells stock to the public for the first time.

The main reason for an IPO is to raise capital for a company often to help it to expand.

In an initial public offering, the company uses the help of an underwriting firm to help it decide which type of stock to issue (preferred or common). They also get assistance deciding on a price and a suitable time to bring the IPO to the marketplace.

What is the difference between a public and private company?

A private company’s stock is not traded publicly on a stock exchange, like the NYSE. A private company can still have shares, but they are traded privately. It may be possible to buy shares in private companies, but the current owners are under no obligation to sell them to you.

With a public company, their stock is traded openly, anybody with the funds can buy them. Investors in public companies often range from large institutional investors to small individual investors.

A public company is required to submit comprehensive financial information to the SEC. A lot of this information is made public for everyone to see. Even your nosey neighbor can have a look if they really wanted to. More realistically, it can be particularly useful for potential investors to view prior to making a decision on the stock.

Advantages of an IPO

No such thing as bad publicity right? An IPO is likely to be in the financial news. This could have many positive spin offs like increased sales andincreased brand awareness.

More money
An IPO will allow the company to increase capital. This is often used to help a business expand.

The valuation is made by the public. After an IPO a stock finds it value. Like with most things, a company is only worth what somebody is prepared to pay for it.

Easy to buy and sell
If you own stock in a public company, it can be a lot easier to sell than stock in a private company. Most major stock exchanges are highly liquid and full of buyers and sellers.

Disadvantages of an IPO

Perhaps the biggest disadvantage of an IPO is when a company becomes public, anybody can buy shares and this can make it vulnerable to a takeover if a large proportion of the stock is traded. This could leave the possibility for a company’s founders to no longer have a controlling share.

Risk of stock crashing
As with all stocks, they will be volatility. If a company’s stock price falls considerably, this could have many knock-on effects for the business including increased difficulty obtaining credit and lowered net worth of investors. It may also may it harder to keep hold of employees if they fear the company may be heading for trouble.

It isn’t cheap
You certainly need some cash if you are going to take the IPO route. Underwriting fees can be around 10% of the value of the entire offering, making investing in a company’s IPO costly.

What about IPO’s as an investment?

You can invest in IPO’s, but it is only a good idea if you have a high tolerance for risk. Immediately after an IPO a stock has not had chance to find its value. This can result in some extremely high volatility.

Some stocks move in excess of 15% on the day of the IPO. If have a high tolerance for risk, an IPO might be right up your street. Be careful.