What is an IPO?

IPO stands for initial public offering. Sounds like jargon, right? It simply means the first sale of stock a company makes. It allows a company to raise cash by issuing equity in the form of stock.

A private or public affair?

A public company can have many hundreds or thousands of shareholders. They can range from small individual investors right through to the major institutional investors. Public companies are required to submit detailed financial information to the SEC.

The financial data is publicly available so potential investors can have a detailed look at the financials of a company when considering purchasing stock.

The price of a public company is traded freely on a stock exchange in a similar way to other financial instruments like currencies, oil etc.

If you want to buy shares in a public company, nobody can stop you. Even if the chief executive of the company really hates you for it, there is nothing he or she can do.

Private companies on the other hand are very different. They may have shareholders, but their shares are not publicly traded. It may be possible to purchase stocks in private companies, but the current stock owners are under no obligation to sell them to you unlike a public company.

Going public

When a company issues shares for the first time, it is also known as “going public”, you may have heard this phrase before. By issuing shares, the current owners of the company are forfeiting a portion of their share in the company in order to raise capital.

What are the advantages of a going public?

Increased Capital
An IPO allows a company to raise capital to aid the growth of the business. Capital raised from IPOs are commonly used for acquisitions, research and development, working capital, market, equipment etc.

Value
After an IPO, a company’s value is set by the public market through the buying and selling of its stock. This valuation may carry a lot more weight than an individuals potentially subjective valuation of their own company.

Liquidity
Once a company has their shares traded on a public stock exchange, these shares have a market value and can be easily resold. It could be a lot more difficult for a private company to their company shares.

Publicity
Don’t they say there is no such thing as bad publicity? It is often the case that an IPO will hit the headlines putting the company issuing shares for the first time into the news. This has the potential to subsequently increase the company’s sales and possibly market share.

Disadvantages of an IPO

Expensive
An IPO can be both very time consuming and expensive. Underwriting fees can often be upto 10% of the value of the offering and it can take a year or more to complete. There aren’t many companies that can afford this time or expense.

Takeover risk
If a large percentage of a companies stock is traded on a stock market, it will mean the company could be vulnerable to a takeover which may mean the founders of the company no longer have a controlling share.

Takeovers are often the result of investors being dissatisfied with the current management or other companies seeking out a business opportunity they feel they can profit from.

Disclosure to the SEC
The SEC disclosure rules are very comprehensive. I’ll be honest, I am not an American and all the rules and regulations go way over my head. However, if you want to know more about this the SEC have a very indepth PDF (adobe acrobat) file on the subject.

Falling Stock Price
When a stock is traded on the open market, there is always a risk of the stock price falling considerably. This could have an impact on a company’s ability to obtain credit, keep employees and will affect the net worth of investors and insiders.

Should you invest in an IPO?
IPOs are often considered to be very risky. As with most high risk investments, there is potential for high returns or big losses. As companies that decide to go the IPO route have no historical stock prices to analyze, it can be considered a “shot in the dark” to an extent.

Stock prices can be very volatile when a stock is just listed on a stock exchange. I remember google’s IPO. The stock jumped around 17% that day. This is not an uncommon occurrence.

Essentially, only you can decide if your risk tolerance is in line with the potential high risk and volatility of IPO investing. As with all kinds of trading and investing, always be sure to have a good set of trading rules.