What does an IPO stand for?
IPOs – anticipation, excitement and opportunity. You’ve seen the buzz word on the front of headlines, but what actually are they?
An IPO is an acronym for an Initial Public Offering.
What is an IPO?
Companies often require external financing to grow, and debt isn’t always a viable option. An IPO gives a company the opportunity to raise money through selling shares in their company to the public for the first time.
The public refers to retail and institutional investors that can buy these shares on a stock exchange. The largest stock exchange in Australia is the Australian Securities Exchange (ASX) and can be accessed through brokers like Maqro Capital.
How do IPOs work?
An IPO is an exciting time for a company as its shares become traded on a stock exchange and the company’s value is determined by the market forces of supply and demand. That is, the public, both retail and institutional investors can buy and sell the stock which changes the price.
When a company lists on the stock exchange, a detailed ‘prospectus’ is provided to the public to assess the quality of the business, understand its risks and operational exposures. This is an audited document that contains a large amount of insight into the company and can help guide the decision to invest in the company or not.
You may have seen company CEOs ringing a bell on the day that they IPO. This is a tradition in the ASX where a company rings the bell on the ASX trading floor symbolising the beginning of their company shares being traded on the exchange.
Once the trading session opens, shares trade openly on the stock exchange allowing investors to buy and sell its shares.
Before an IPO, a company is considered private. This means that the general public cannot generally buy stock or own any shares in these companies. After an IPO, the company’s shares are now traded on a stock exchange and can be bought by the general public – this makes the firm a public company.
To IPO, a company must engage with a financial advisor to facilitate the process. This is usually performed by an investment bank and involves dealing with paperwork, regulatory procedures set by ASIC and the determination of a listing price.
A listing price is important for a company as it determines the price that shares will initially be offered to investors on the stock exchange. The listing price of a company’s shares, also known as the IPO price, is often not the same as the close price on its first day of trading.
An IPO also provides a great platform for a company to be marketed. Some firms embrace the opportunity to get their brand out there in the public and can benefit from increased exposure. Once a company is listed, it can then raise any future money through issuing more stock to investors which can then be traded on a stock exchange.
How does an IPO affect investors?
IPOs provide an additional opportunity in one’s investable universe. Before a company IPOs and lists on a stock exchange it is very hard for the average investor to buy equity and own shares in it. Due to this, an IPO allows investors to access a new company with its own unique management team, operational diversification and growth potential. When the shares become publicly listed, all investors are able to buy shares in the company as they would any other ordinary share on the market.
Although IPOs present an exciting opportunity, it is key to note there are risks involved. Firstly, as any equity investment, each company bears its own unique risks that investors should consider. Secondly, the share price on an IPO day tends to be quite volatile and could close below the listing price. Finally, it can be hard to determine what fair price is for a newly listed firm as there is no historical price action to benchmark relative value.
An IPO is an exciting time full of opportunity and in the past has formed part of successful investment strategies for investors. A company’s prospectus is a reliable source document that is audited and can help form an investment thesis or conviction in making your investment decision.