IPO
Initial Public Offerings
An IPO, Initial Public Offering, or simply “public offering,” is a private company’s first sale of stock to the public. Small and young companies needing capital to expand are the most likely to issue an IPO; however, large, privately owned companies will also issue IPOs when looking to gain more capital for growth. Whenever a company first issues shares on a public exchange, it will likely also issue new shares at the same time in order to raise extra funds. During an IPO, the money for the newly issued shares comes from the investors and goes directly to the company, while a later trade of shares would cause the money to pass between investors. Therefore, an IPO enables a company to take advantage of a large assortment of stock market investors who will provide the company with the capital it needs for future development. Once a company is publicly listed, it will have the right to issue more shares, giving the company a limitless source of income for expansion without incurring debt. In addition to financing growth, Initial Public Offerings are also attractive to businesses because IPOs give companies the ability to raise significant funds from the general market, without having to deal with private investors.
In order to offer an IPO, the issuing company must obtain the assistance of one or more underwriting firms or a syndicate of investment banks that will help the company determine which security is the best to offer, common or preferred, at what price, and at what time, thereby maximizing the IPO’s earning potential. The allocation and pricing of the shares, known as “the sale,” may take several forms, but some of the common methods are a best efforts, firm commitment, and self-distribution of stock, with Dutch auction and bought deal comprising the majority of sales. For a Dutch auction, the stock is offered at a high price, and then the price is increasingly lowered until an investor is willing to accept the price or until the issuer’s minimum, or reserve price, is reached. A bought deal entails the underwriter purchasing the securities before selling them publicly. Once a sale method is determined, the issuer signs a contract with the lead underwriter detailing how the shares will be sold publicly, and then the underwriter markets them to investors.
Although the issuer is never required to repay its investors once they purchase the stock, shareholders have a right to the profits the company distributes. Nevertheless, IPOs can be a risky venture for an individual investor. Stocks can be unpredictable on their initial day of trading, and since investors do not have the stocks’ historical statistics to fall back on, analyzing the companies’ future may be difficult. In addition, most companies offering an IPO are going through financial, as well as structural, changes, and the profitability of the company and the stocks’ value may be uncertain. Furthermore, as the company continues to issue more stock, investors’ holdings in the company will be diluted, and investors can only hope the stocks will rise in value to offset the dilution. If you are considering investing in an IPO, the most important thing is to do your research, selecting an issuer that is backed by reputable underwriters.