Going Public: What Is an IPO Stock?
There are around 4,000 companies that sell shares within their businesses on United States stock exchanges.
So, what is an IPO and why would you want to invest in one? Furthermore, how do you even do it once you decide an IPO is something you are interested in?
Knowing what you are buying and trading is important if you want to get into the world of trading and stock markets.
Find out more about the reasons an IPO investment may be a wise choice in certain situations by reading below.
What is an IPO?
An IPO is a type of public offering where shares of a company can be sold to investors. Also called an initial public offering or a stock market launch, IPOs are great for people that want to get into investing and have the money to make it happen.
In order for an IPO to exist, it must be underwritten by at least one investment bank who will also help to arrange for the shares to be available on stock exchanges.
When a privately held company decides to “go public” and have a public offering, it becomes a public company. Generally, this is done to earn more money for the company, monetize investments of shareholders, or make it easier to trade current and future capital raised from the trading.
After an IPO is created, the shares can be traded in an open market. This is called free float. Stock exchanges can come from a small free float in absolute terms and also as a proportion of total shares’ capital. IPOs have a lot of benefits, but they can be expensive in terms of legal and banking fees.
A document, called a prospectus, is given to potential purchasers of the IPO that will give information about the proposed offering before it happens.
A lot of companies will start and complete the process of creating an IPO with the help of an investment banking firm. They will act as the underwriter and provide a lot of important services to make it a success. The underwriter assesses the value of shares and helps establish the public market for shares.
Benefits of Initial Public Offering Opportunities
If a company lists securities on a public exchange, the money that is paid by investors will go directly to the company. It also goes to any of the early private investors that are trying to sell some holdings as part of the whole, larger IPO.
This whole process will allow an IPO to help a company find more investors to give itself even bigger growth in the future and a higher amount of working capital. Any company selling common shares is not required to pay back the capital to public investors, so they must endure the nature of open market prices and trades with this in mind.
After an IPO is released, the shares are traded freely and the money passes between the various public investors that are interested.
Early private investors are able to choose to sell shares as part of the entire process with an initial public offering as the IPO is a new opportunity for them to monetize from early investing.
Investors that hold a lot of shares can also sell their shares in pieces or as a large block directly at a fixed price to the public. This is not dilutive as an offering because there aren’t any new shares that are being generated.
An IPO can give the following benefits to a private company:
- Increased exposure and public image
- Cheaper access to more capital opportunities
- A larger equity base
- Facilitation of acquisitions
- Multiple financing opportunities for more growth
- Increased prestige publicly
How Does a Company Get Additional Common Shares?
In some cases, a company may need to raise money for funding after they go public. This could be for general operations or it could be for something more strategic, like expansion or development plans.
After a company is listed, they can get additional common shares in a lot of ways.
One of the best and easiest ways is a follow-on offering. This will allow a company to get capital for a lot of different purposes through issuing equity without getting extra debt.
This lets a company get money much faster from the marketplace and is a great reason for a company to decide to go public.
It’s important for a company to consider this in full before doing so, however, because an increase in total capital stock can impact current shareholders in a negative way. Share dilution may occur, giving each share a smaller percentage of value and ownership.
Investing in an IPO
There are actually many factors that will impact the return you may get from an IPO and its often watches very closely by investors. Some of the IPOs are not as strong as investment banks may lead you to believe, but many of them are known for gaining at least short-term trading.
These are some of the considerations you have to take into account when thinking about IPO performance.
IPOs usually can have opening day returns that will attract investors that want a discount from the beginning. Over a long-term, however, an IPO will fall into a steady value and it will be followed with traditional stock price metrics.
Investors that like the idea of an IPO and might not want to take the risk with individual stocks will want to look at managed funds focusing on IPOs.
There are some investment banks that will require waiting periods for their offering terms. This will set aside some shares for purchases made after a specific period of time.
The price may go up if this allocation is then bought by underwriters, but it will go down if it is not purchased.
Sometimes, you can see that an IPO stock will take a steep downturn within months. This is generally because the lock-up period has expired.
Whenever a company decides to go public, the underwriters will have company insiders sign a lock-up agreement. Lock-up agreements are legal contracts that will prohibit insiders of the company from selling shares of stock for a specific amount of time.
This period of time can be somewhere between 3 to 24 months. The amount of time is going to depend on what the underwriters have decided is most appropriate for that specific company.
When a lockup expires, all the insiders are allowed to sell stock and sometimes everyone wants to sell to realize the profit. This can put extra pressure on the stock price.
Tracking Stock Prices
A company can create tracking stocks by spinning off a specific part of the business as its own entity. The rationale behind doing this is that individual divisions of a company can be worth more than the company as a whole.
An example of this is if a division of the company has a lot of growth potential, but current losses overall within the company are creating an issue, carving out the promising section can be lucrative.
It can be interesting to have these types of IPO options when you are an investor. A spin-off of a whole company will provide investors with a lot of information regarding the company as a whole and the stake in the divesting company.
Giving potential investors more information is good because you will attract more people to your company’s IPO and high-quality investors will be able to find good opportunities.
This is when an IPO stock is resold soon after its available in order to get a fast profit. Flipping often happens if the stock is discounted at launch and then soars to higher amounts after the first day of trading.
While flipping can be a great thing for investors that choose to do it, it can definitely impact the overall value of the stock itself when a lot of people are selling at once.
Understanding IPO Stocks Moving Forward
What is an IPO? It’s an opportunity for a company to create a bigger name for itself while making more money, but it’s also an opportunity for investors to make more money and build their portfolio even more.
When investing in any type of stock, you need to consider the advantages and disadvantages of doing so. An IPO can be a lucrative investment if you know what you are doing.
If you’re interested in getting more guidance regarding IPO investment, check out our website to see if we may be able to give you more information.