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An initial public offering or IPO can be an exciting opportunity for investors to buy shares in a company when it first goes public. It’s the first chance that most investors get to own a slice of some of the most exciting private businesses that have decided to go public.
An IPO, also known as a flotation or stock market listing, is where a private company sells new shares to public investors. It’s a way of raising capital to fund further growth and innovation, and it also allows existing investors to reap the rewards of backing the company during its start-up phase.
Up until this point, the company is privately owned by the people founded it, and any staff or early investors who were given shares.
A company that wishes to go public will need to meet certain criteria laid out by the domestic market regulator – such as the Securities and Exchange Commission (SEC) in the United States. Companies can also choose what exchange they want to list on, such as the New York Stock Exchange or the NASDAQ, and these too have their own requirements.
Companies need the help of an underwriter or underwriters to hold an IPO. These are investment banks such as Goldman Sachs, Morgan Stanley, and JPMorgan, and are responsible for arranging and marketing the initial public offering.
It’s common for underwriters to assume all the risk of the IPO by buying all of the new shares being issued by the company, and then selling the stock to public investors.
In the run-up to an IPO, a company will issue a prospectus and hold investor roadshows across the country in which it is listing in order to drum up interest in the flotation. The prospectus will give a target price range for the shares to be issued. This is often adjusted to reflect market demand as the company’s stock debut draws near.
Sometimes the stock of the company is so in demand ahead of its initial public offering that the company decides to issue more shares than originally planned – usually the underwriters are given the power to automatically increase the size of the issuance by a set amount of shares if demand warrants it.
Although the underwriter buys the new shares at the final initial offer price, the stock can open above or below this price on its first day of trading. If the company going public and the underwriters have overestimated demand for the stock, the underwriter may have to sell the shares for a lower price than it bought them. And if demand has been underestimated, the underwriter may be able to sell the stock for a much higher price than it bought them. Doing so is likely to damage their reputation, however, so underwriters have an incentive to try and sell the shares for as close to the initial offer price as possible.
Companies who don’t want to hold an initial public offering may instead opt for a direct listing. With an IPO, the company going public is selling new shares, giving away control of more of the business. A direct listing, on the other hand, is where a company allows its existing shareholders to sell the stock on public markets. This allows early investors to reap the benefits of backing the company, and allows the company to trade publicly without giving away control through the issuing of new shares. A company does not need to hire underwriters in order to hold a direct listing – saving it a lot of money in fees. This also means existing investors may be able to sell their stock for a higher price.
Companies who don’t want to hold an initial public offering may instead opt for a direct listing. With an IPO, the company going public is selling new shares, giving away control of more of the business. A direct listing, on the other hand, is where a company allows its existing shareholders to sell the stock on public markets. This allows early investors to reap the benefits of backing the company, and allows the company to trade publicly without giving away control through the issuing of new shares. A company does not need to hire underwriters in order to hold a direct listing – saving it a lot of money in fees. This also means existing investors may be able to sell their stock for a higher price.
Sign up for a share dealing account to get all the latest information about forthcoming IPOs and how to buy shares in the companies going public.
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