An initial public offering (IPO) is the first sale of stock issued by a company. In other words, it’s when a business decides to start selling its shares to the public. The company will decide how many shares it wants to offer, and an investment bank will suggest an initial price for the stocks based on the predicted demand for them.
Why do companies want to go public?
Companies want to go public for different reasons, depending on their circumstances. Most are looking to raise capital to fund expansion, pay debts, attract and retain talent, or monetise assets. A company may also want to list on a stock exchange to improve its public profile.
How does the IPO process work?
The IPO process starts when a company decides that it wants to sell its shares to the public via a stock exchange. First, an audit must be conducted – considering all aspects of a company’s financials.
If everything is in order, the business then has to prepare a registration statement to file with the appropriate exchange commission, such as the SEC. Next, the stock exchange reviews the application, after which it is either accepted – sometimes subject to certain amendments – or rejected. If it is approved, the company will list a defined number of shares and they will be available for sale through the chosen stock exchange.
Who sets the IPO price?
Investment banks set the IPO price. The company decides how many of its shares it wants to sell to the public and then the nominated investment bank does a valuation of the business. Once that’s done, an initial share price is released, and the public can start trading shares when the listing happens.
Pros and cons of IPOs
Pros of IPOs
A successful IPO can raise huge amounts of capital, as becoming listed on a stock exchange can help to increase the exposure and public image of a company. In turn, the firm’s sales and profit can increase. IPOs are also beneficial to traders because it’s easier to buy publicly traded shares than those that only trade privately.
Cons of IPOs
Public companies are subjected to the rules and regulations of a governing body. One of the rules is that it is required to publicly disclose financials, such as accounting information, tax and profits. IPOs also carry significant costs and could require the company to raise additional funding if its shares perform poorly.
How to trade or invest in an IPO
Before the listing
Some IPOs get a lot of interest from the public before they happen. In these cases, a ‘grey market’ – enabling you to speculate on the company’s share price before the IPO – may be available.
A grey market price is based on a prediction of the company’s market cap at the end of the first trading day. To trade the grey market, open a CFD trading or spread betting account and then:
- ‘Buy’ (go long) if you think the market cap will be higher than the grey market price
- ‘Sell’ (go short) if you think the market cap will be lower than the grey market price
After the listing
When an IPO has happened, you can start trading or investing in shares, as you would any other shares on the stock market.
- Go long or short on share prices by spread betting and CFD trading
- Buy and own shares via share dealing
Remember, if you’re trading, you can profit from upward or downward share price movements. But if you’re investing in shares, you can only profit from rising share prices and dividend payments – if made by the company.
The length of the IPO process can vary, depending on how well it’s being managed and coordinated. The first step is a financial audit of the company, which can be the longest part of the process – especially if the company’s books are not in order.
The business then has to prepare a registration statement to file for the IPO. The next step is to allow the stock exchange to review the application. This can happen quickly if it has no concerns. A well-managed IPO could take up to 12 months, but it could be longer.
Any company wanting to list on a stock exchange has to carry the cost of an IPO – no costs are carried by the individual trader or investor before they start trading or investing. Charges differ for spread betting and CFD trading, and share dealing.
The cost of an IPO for a company will depend on the registration requirements of the stock exchange where it is being listed. In addition, there will generally be underwriting fees and offering costs, as well as legal and accounting fees. Larger companies could face additional costs when preparing to list.
The IPO price is calculated by an investment bank. First, the company decides how many of its shares it wants to sell to the public. Then, the nominated investment bank does a thorough valuation of the business. Once that’s done, an initial share price is released, and the public can start trading shares when the listing happens.
Alternatives to IPOs
An IPO is not the only way for a business to get access to the public market. Other options include direct listings, reverse takeovers and Dutch auctions.
A direct listing enables a company to list on a stock exchange without an underwriter. They occur when a business decides not to issue new shares but, instead, to offer existing shareholders the option to sell their shares to the public. Direct listings can happen much faster than IPOs, cost much less, and don’t dilute existing shareholders’ positions. An example of a company that undertook a direct listing is Spotify.
A reverse takeover happens when a private company takes over a public firm. In other words, the companies merge to offer shares to the public. It is a more cost-effective and time-efficient way to list shares compared to a regular IPO. An example of a company that decided to go public through a reverse takeover is Virgin Galactic.
A Dutch auction happens when the price of the IPO is set by taking bids for the number of shares investors want to buy, and the price they want to pay. After the auction, underwriters will determine the highest price at which all the company’s shares can be floated. An example of a company that decided to go public through a Dutch auction is Google (Alphabet).
*This article was first published on ig.com