- Video of the Day
- Initial Public Offering (IPO)
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- Four Ways an IPO Can Hurt or Help Your Business
- Pre-market Purchases
- 2 Ways How to Buy IPO Stocks before First Day of Trading
- How does an IPO work?
- Purchasing IPO Stock
- Don't Buy IPO Stocks!!
- What is an IPO in the share market?
- What is a health ipo i can buy shares of
What Is an IPO?
An initial public offering (IPO) refers to the process of offering shares of a private corporation to the public in a new stock issuance. Public share issuance allows a company to raise capital from public investors.
The transition from a private to a public company can be an important time for private investors to fully realize gains from their investment as it typically includes share premiums for current private investors. Meanwhile, it also allows public investors to participate in the offering.
A company planning an IPO will typically select an underwriter or underwriters. They will also choose an exchange in which the shares will be issued and subsequently traded publicly.
The term initial public offering (IPO) has been a buzzword on Wall Street and among investors for decades.
The Dutch are credited with conducting the first modern IPO by offering shares of the Dutch East India Company to the general public. Since then, IPOs have been used as a way for companies to raise capital from public investors through the issuance of public share ownership.
Through the years, IPOs have been known for uptrends and downtrends in issuance. Individual sectors also experience uptrends and downtrends in issuance due to innovation and various other economic factors.
Tech IPOs multiplied at the height of the dot-com boom as startups without revenues rushed to list themselves on the stock market. The 2008 financial crisis resulted in a year with the least number of IPOs. After the recession following the 2008 financial crisis, IPOs ground to a halt, and for some years after, new listings were rare.
More recently, much of the IPO buzz has moved to a focus on so-called unicorns—startup companies that have reached private valuations of more than $1 billion.
Investors and the media heavily speculate on these companies and their decision to go public via an IPO or stay private.
How IPOs Work
Prior to an IPO, a company is considered private.
As a private company, the business has grown with a relatively small number of shareholders including early investors like the founders, family, and friends along with professional investors such as venture capitalists or angel investors.
When a company reaches a stage in its growth process where it believes it is mature enough for the rigors of SEC regulations along with the benefits and responsibilities to public shareholders, it will begin to advertise its interest in going public.
Typically, this stage of growth will occur when a company has reached a private valuation of approximately $1 billion, also known as unicorn status. However, private companies at various valuations with strong fundamentals and proven profitability potential can also qualify for an IPO, depending on the market competition and their ability to meet listing requirements.
An IPO is a big step for a company.
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It provides the company with access to raising a lot of money. This gives the company a greater ability to grow and expand. The increased transparency and share listing credibility can also be a factor in helping it obtain better terms when seeking borrowed funds as well.
IPO shares of a company are priced through underwriting due diligence. When a company goes public, the previously owned private share ownership converts to public ownership and the existing private shareholders’ shares become worth the public trading price.
Share underwriting can also include special provisions for private to public share ownership. Generally, the transition from private to public is a key time for private investors to cash in and earn the returns they were expecting.
Private shareholders may hold onto their shares in the public market or sell a portion or all of them for gains.
Meanwhile, the public market opens up a huge opportunity for millions of investors to buy shares in the company and contribute capital to a company’s shareholders' equity.
The public consists of any individual or institutional investor who is interested in investing in the company. Overall, the number of shares the company sells and the price for which shares sell are the generating factors for the company’s new shareholders' equity value. Shareholders' equity still represents shares owned by investors when it is both private and public, but with an IPO the shareholders' equity increases significantly with cash from the primary issuance.
Underwriters and the IPO Process
An IPO comprehensively consists of two parts.
The first is the pre-marketing phase of the offering, while the second is the initial public offering itself. When a company is interested in an IPO, it will advertise to underwriters by soliciting private bids or it can also make a public statement to generate interest. The underwriters lead the IPO process and are chosen by the company.
A company may choose one or several underwriters to manage different parts of the IPO process collaboratively. The underwriters are involved in every aspect of the IPO due diligence, document preparation, filing, marketing, and issuance.
Steps to an IPO include the following:
Initial Public Offering (IPO)
Underwriters present proposals and valuations discussing their services, the best type of security to issue, offering price, amount of shares, and estimated time frame for the market offering.
2. The company chooses its underwriters and formally agrees to underwriting terms through an underwriting agreement.
3. IPO teams are formed comprising underwriters, lawyers, certified public accountants, and Securities and Exchange Commission experts.
Information regarding the company is compiled for required IPO documentation.
a. The S-1 Registration Statement is the primary IPO filing document. It has two parts: The prospectus and the privately held filing information. The S-1 includes preliminary information about the expected date of the filing. It will be revised often throughout the pre-IPO process. The included prospectus is also revised continuously.
Marketing materials are created for pre-marketing of the new stock issuance.
a. Underwriters and executives market the share issuance to estimate demand and establish a final offering price. Underwriters can make revisions to their financial analysis throughout the marketing process.
This can include changing the IPO price or issuance date as they see fit.
b. Companies take the necessary steps to meet specific public share offering requirements. Companies must adhere to both exchange listing requirements and SEC requirements for public companies.
Form a board of directors.
7. Ensure processes for reporting auditable financial and accounting information every quarter.
The company issues its shares on an IPO date.
a. Capital from the primary issuance to shareholders is received as cash and recorded as stockholders' equity on the balance sheet.
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Subsequently, the balance sheet share value becomes dependent on the company’s stockholders' equity per share valuation comprehensively.
9. Some post-IPO provisions may be instituted.
a. Underwriters may have a specified time frame to buy an additional amount of shares after the initial public offering date.
Certain investors may be subject to quiet periods.
Corporate Finance Advantages
The primary objective of an IPO is to raise capital for a business. It can also come with other advantages.
• The company gets access to investment from the entire investing public to raise capital.
• Facilitates easier acquisition deals (share conversions).
Can also be easier to establish the value of an acquisition target if it has publicly listed shares.
• Increased transparency that comes with required quarterly reporting can usually help a company receive more favorable credit borrowing terms than as a private company.
• A public company can raise additional funds in the future through secondary offerings because it already has access to the public markets through the IPO.
• Public companies can attract and retain better management and skilled employees through liquid stock equity participation (e.g.
ESOPs). Many companies will compensate executives or other employees through stock compensation at the IPO.
• IPOs can give a company a lower cost of capital for both equity and debt.
• Increase the company’s exposure, prestige, and public image, which can help the company’s sales and profits.
Disadvantages and Alternatives
Companies may confront several disadvantages to going public and potentially choose alternative strategies.
Some of the major disadvantages include the following:
• An IPO is expensive, and the costs of maintaining a public company are ongoing and usually unrelated to the other costs of doing business.
• The company becomes required to disclose financial, accounting, tax, and other business information. During these disclosures, it may have to publicly reveal secrets and business methods that could help competitors.
• Significant legal, accounting, and marketing costs arise, many of which are ongoing.
• Increased time, effort, and attention required of management for reporting.
• The risk that required funding will not be raised if the market does not accept the IPO price.
• There is a loss of control and stronger agency problems due to new shareholders who obtain voting rights and can effectively control company decisions via the board of directors.
• There is an increased risk of legal or regulatory issues, such as private securities class action lawsuits and shareholder actions.
• Fluctuations in a company's share price can be a distraction for management which may be compensated and evaluated based on stock performance rather than real financial results.
• Strategies used to inflate the value of a public company's shares, such as using excessive debt to buy back stock, can increase the risk and instability in the firm.
• Rigid leadership and governance by the board of directors can make it more difficult to retain good managers willing to take risks.
Having public shares available requires significant effort, expenses, and risks that a company may decide not to take.
Remaining private is always an option. Instead of going public, companies may also solicit bids for a buyout. Additionally, there can be some alternatives that companies may explore.
A direct listing is when an IPO is conducted without any underwriters.
Direct listings skip the underwriting process, which means the issuer has more risk if the offering does not do well, but issuers also may benefit from a higher share price. A direct offering is usually only feasible for a company with a well-known brand and an attractive business.
In a Dutch auction, an IPO price is not set. Potential buyers are able to bid for the shares they want and the price they are willing to pay.
The bidders who were willing to pay the highest price are then allocated the shares available. In 2004, Alphabet (GOOG) conducted its IPO through a Dutch auction. Other companies like Interactive Brokers Group (IBKR), Morningstar (MORN), and The Boston Beer Company (SAM) also conducted Dutch auctions for their shares rather than a traditional IPO.
Investing in IPOs
When a company decides to raise money via an IPO it is only after careful consideration and analysis that this particular exit strategy will maximize the returns of early investors and raise the most capital for the business.
Four Ways an IPO Can Hurt or Help Your Business
Therefore, when the IPO decision is reached, the prospects for future growth are likely to be high, and many public investors will line up to get their hands on some shares for the first time. IPOs are usually discounted to ensure sales, which makes them even more attractive, especially when they generate a lot of buyers from the primary issuance.
Initially, the price of the IPO is usually set by the underwriters through their pre-marketing process.
At its core, the IPO price is based on the valuation of the company using fundamental techniques. The most common technique used is discounted cash flow, which is the net present value of the company’s expected future cash flows.
Underwriters and interested investors look at this value on a per-share basis. Other methods that may be used for setting the price include equity value, enterprise value, comparable firm adjustments, and more.
The underwriters do factor in demand but they also typically discount the price to ensure success on the IPO day.
It can be quite hard to analyze the fundamentals and technicals of an IPO issuance. Investors will watch news headlines but the main source for information should be the prospectus, which is available as soon as the company files its S-1 Registration.
The prospectus provides a lot of useful information. Investors should pay special attention to the management team and their commentary as well as the quality of the underwriters and the specifics of the deal.
Successful IPOs will typically be supported by big investment banks that have the ability to promote a new issue well.
Overall, the road to an IPO is a very long one. As such, public investors building interest can follow developing headlines and other information along the way to help supplement their assessment of the best and potential offering price.
The pre-marketing process typically includes demand from large private accredited investors and institutional investors which heavily influence the IPO’s trading on its opening day. Investors in the public don’t become involved until the final offering day. All investors can participate but individual investors specifically must have trading access in place.
2 Ways How to Buy IPO Stocks before First Day of Trading
The most common way for an individual investor to get shares is to have an account with a brokerage platform that itself has received an allocation and wishes to share it with its clients.
• Alibaba Group (BABA) in 2014 raising $25 billion
• Softbank Group (SFTBF) in 2018 raising $23.5 billion
• American Insurance Group (AIG) in 2006 raising $20.5 billion
• VISA (V) in 2008 raising $19.7 billion
• General Motors (GM) in 2010 raising $18.15 billion
• Facebook (FB) in 2012 raising $16.01 billion
There are several factors that may affect the return from an IPO which is often closely watched by investors.
Some IPOs may be overly-hyped by investment banks which can lead to initial losses. However, the majority of IPOs are known for gaining in short-term trading as they become introduced to the public.
There are a few key considerations for IPO performance.
If you look at the charts following many IPOs, you'll notice that after a few months the stock takes a steep downturn.
This is often because of the expiration of the lock-up period. When a company goes public, the underwriters make company insiders such as officials and employees sign a lock-up agreement.
Lock-up agreements are legally binding contracts between the underwriters and insiders of the company, prohibiting them from selling any shares of stock for a specified period of time. The period can range anywhere from three to 24 months. Ninety days is the minimum period stated under Rule 144 (SEC law) but the lock-up specified by the underwriters can last much longer. The problem is, when lockups expire, all the insiders are permitted to sell their stock.
The result is a rush of people trying to sell their stock to realize their profit.
How does an IPO work?
This excess supply can put severe downward pressure on the stock price.
Some investment banks include waiting periods in their offering terms.
This sets aside some shares for purchase after a specific period of time. The price may increase if this allocation is bought by the underwriters and decrease if not.
Flipping is the practice of reselling an IPO stock in the first few days to earn a quick profit. It is common when the stock is discounted and soars on its first day of trading.
Closely related to a traditional IPO is when an existing company spins off a part of the business as its own standalone entity, creating tracking stocks.
The rationale behind spin-offs and the creation of tracking stocks is that in some cases individual divisions of a company can be worth more separately than as a whole. For example, if a division has high growth potential but large current losses within an otherwise slowly growing company, it may be worthwhile to carve it out and keep the parent company as a large shareholder then let it raise additional capital from an IPO.
From an investor’s perspective, these can be interesting IPO opportunities.
In general, a spin-off of an existing company provides investors with a lot of information about the parent company and its stake in the divesting company. More information available for potential investors is usually better than less and so savvy investors may find good opportunities from this type of scenario. Spin-offs can usually experience less initial volatility because investors have more awareness.
IPOs are known for having volatile opening day returns that can attract investors looking to benefit from the discounts involved.
Over the long-term, an IPO's price will settle into a steady value which can be followed by traditional stock price metrics like moving averages. Investors who like the IPO opportunity but may not want to take the individual stock risk may look into managed funds focused on IPO universes. There are a few IPO index funds or ETFs that can also be a good investment such as the First Trust U.S. Equity Opportunities ETF (FPX).
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You don’t have to know everything to start investing.
In fact, if you wait until you know everything before you get started, you’ll probably never start investing at all! But there are some basic terms you might want to have in your investing arsenal.
These terms will be helpful to understand, so you don’t end up missing something you should know, or veering away from your financial goals.
And it never hurts to know the basics.
Below are 25 most common investing terms and definitions:
1. Ask: This is the lowest price an owner is willing to accept for an asset.
2. Asset: Something that has the potential to earn money for you.
It is something you own that can reasonably be expected to produce something for you. Assets include stocks, bonds, commodities, real estate, and other investments.
Asset allocation: One of the ways to divide up the holdings in your portfolio is to do so by asset class. The idea is that different assets perform opposite to each other, and you can limit some of your risk by allocating your portfolio according to the type of asset you have.
Balance sheet: A statement showing what a company owns, as well as the liabilities the company has, and stating the outstanding shareholder equity.
5. Bear market: This is a market that is falling.
Purchasing IPO Stock
A bear market has a downward trend, and someone who believes the market is headed for a drop is often referred to as a “bear.”
6. Bid: This is the highest price a buyer is willing to pay when buying an investment. Today, electronic trading makes it possible for ask and bid to be matched up automatically and almost instantly.
Blue chip: You might hear reporters and others refer to “blue chip stocks.” Blue chips are companies that have a long history of good earnings, good balance sheets, and even regularly increasing dividends.
These are solid companies that may not be exciting, but they are likely to provide reasonable returns over time.
8. Bond: This is an investment that represents what an entity owes you.
Essentially, you lend money to a government or a company, and you are promised that the principal will be returned plus interest.
9. Book value: If you take all the liabilities a company has, and subtract them from the assets and common stock equity of the company, what you would have left over is the book value. Most of the time, the book value is used as part of an evaluative measure, rather than being truly related to a company’s market value.
Broker: This is the entity that buys and sells investments on your behalf. Usually, you pay a fee for this service. In the case of an online discount broker, you often pay a flat commission per trade. Other brokers, especially if they also manage your assets as a whole, just charge a percentage of your assets each year.
11. Bull market: This is a market that is trending higher, likely to gain.
If you think that the market is going to go up, you are considered a “bull.” Additionally, the term, like bear, can be applied to how you feel about an individual investment. If you are “bullish” on a specific company, it means you think the stock price will rise.
Capital gain (or loss): This is the difference between what you bought an investment for and what you sell if for. If you buy 100 shares of a stock at $10 a share (spending $1,000) and sell your shares later for $25 a share ($2,500), you have a capital gain of $1,500.
A loss occurs when you sell for less than you paid. So, if you sell this stock for $5 instead ($500), you have a capital loss of $500).
13. Diversity: A portfolio characteristic that ensures you have more than one type of asset. It also means choosing to buy investments in different sectors, industries, or geographic locations.
Dividend: In some cases, a company will offer to divide up some of its income among shareholders. Dividends can be paid once, as a special use of them, or they can be paid more regularly, such as monthly, quarterly, semi-annually, or annually.
15. Dow Jones Industrial Average: This average includes a price-weighted list of 30 blue chip stocks. While there are only 30 companies included on the list, many people think of the Dow when they here that “the stock market” gained or lost.
The Dow is often used as a gauge of the health of the stock market as a whole, even though it is only a very small portion.
16. Exchange: This is a place where investments, including stocks, bonds, commodities, and other assets are bought and sold. It’s a place where brokers (buyers and sellers) and others can connect. While many exchanges of “trading floors” most orders these days are executed electronically.
Index: A tool used to statistically measure the progress of a group of stocks that share characteristics. This can include a group of stocks, a group of bonds, or a group of other assets.
18. Margin: This is essentially borrowed money used to make an investment. You can get credit from a broker to buy more than you have actually money for.
The hope is that you will make enough money that you will be able to repay the borrowed amount from your earnings.
19. Market capitalization: The market cap of a company is figured by multiplying its current share price by the number of shares outstanding. The largest companies have market caps in the billions.
NASDAQ: This is a stock exchange that focuses on trading the stocks of technology companies.
New York Stock Exchange: One of the most famous stock exchanges is the NYSE, which trades stocks in companies all over the United States, and even includes stocks of some international companies.
22. P/E ratio: This measure reflects how much you pay for each dollar that company earns. A company often reports profits on a per-share basis. So a company might say that it has earned $5 per share.
Don't Buy IPO Stocks!!
If that same stock is selling for $75 a share on the market, you divide $75 by $5 to come up with a P/E ratio of 15. The higher a P/E ratio is, the more there is expectations for higher earnings.
23. Registered Investment Advisor (RIA): A financial investment advisor that has been through certain training, and that agrees to abide by certain rules, including ensuring that recommendations, and trades made on your behalf are in your best interest.
Stock: A stock represents ownership in a company. Companies divide their ownership stakes into shares, and amount of shares you purchase indicates your level of ownership in the company.
Stock is bought in the hopes that the company will be successful, and more people will want a stake, so you can sell your stake later at a higher price than you paid.
25. Yield: This is associated with dividend investing. Your yield represents the ratio between the stock price paid and the dividend paid. A stock trading at $100 per share, with a dividend that amounts to $5 per year, you divide the $5 by $100 and turn it into a percentage.
In this case, the yield would be 5%.
As an investor, you have a lot of options for where to put your money. It’s important to weigh them carefully.
Investments are generally bucketed into three major categories: stocks, bonds and cash equivalents.
There are many ways to invest within each bucket.
Here are six types of investments you might consider for long-term growth, and what you should know about each. Note: We won’t get into cash equivalents — things like money markets, certificates of deposit or savings accounts — as they’re less about growing your money and more about keeping it safe.
A stock is an investment in a specific company. When you purchase a stock, you’re buying a share — a small piece — of that company’s earnings and assets.
Companies sell shares of stock in their businesses to raise cash; investors can then buy and sell those shares among themselves. Stocks sometimes earn high returns, but also come with more risk than other investments.
Companies can lose value or go out of business. Read our full explainer on stocks.
How investors make money: Stock investors make money when the value of the stock they own goes up and they’re able to sell that stock for a profit.
Some stocks also pay dividends, which are regular distributions of a company’s earnings to investors.
» Learn how to buy stocks
A bond is a loan you make to a company or government. When you purchase a bond, you’re allowing the bond issuer to borrow your money and pay you back with interest.
Bonds are generally considered safer than stocks, but they also offer lower returns. The primary risk, as with any loan, is that the issuer could default.
What is an IPO in the share market?
U.S. government bonds are backed by the “full faith and credit” of the United States, which effectively eliminates that risk. State and city government bonds are generally considered the next-safest option, followed by corporate bonds. The safer the bond, the lower the interest rate.
For more details, read our introduction to bonds.
How investors make money: Bonds are a fixed-income investment, because investors expect regular income payments. Interest is generally paid to investors in regular installments — typically once or twice a year — and the total principal is paid off at the bond’s maturity date.
» Learn how to buy bonds
3. Mutual funds
If the idea of picking and choosing individual bonds and stocks isn’t your bag, you’re not alone.
In fact, there’s an investment designed just for people like you: the mutual fund.
Mutual funds allow investors to purchase a large number of investments in a single transaction. These funds pool money from many investors, then employ a professional manager to invest that money in stocks, bonds or other assets.
Mutual funds follow a set strategy — a fund might invest in a specific type of stocks or bonds, like international stocks or government bonds.
Some funds invest in both stocks and bonds. How risky the mutual fund is will depend on the investments within the fund. Read more about how mutual funds work.
How investors make money: When a mutual fund earns money — for example, through stock dividends or bond interest — it distributes a proportion of that to investors.
When investments in the fund go up in value, the value of the fund increases as well, which means you could sell it for a profit. Note that you’ll pay an annual fee, called an expense ratio, to invest in a mutual fund.
» Learn how to invest in mutual funds
4. Index funds
An index fund is a type of mutual fund that passively tracks an index, rather than paying a manager to pick and choose investments. For example, an S&P 500 index fund will aim to mirror the performance of the S&P 500 by holding stock of the companies within that index.
The benefit of index funds is that they tend to cost less because they don’t have that active manager on the payroll.
The risk associated with an index fund will depend on the investments within the fund. Learn more about index funds.
How investors make money: Index funds may earn dividends or interest, which is distributed to investors.
These funds may also go up in value when the benchmark indexes they track go up in value; investors can then sell their share in the fund for a profit.
What is a health ipo i can buy shares of
Index funds also charge expense ratios, but as noted above, these costs tend to be lower than mutual fund fees.
» Learn how to invest in index funds
ETFs are a type of index fund: They track a benchmark index and aim to mirror that index’s performance. Like index funds, they tend to be cheaper than mutual funds because they are not actively managed.
The major difference between index funds and ETFs is how ETFs are purchased: They trade on an exchange like a stock, which means you can buy and sell ETFs throughout the day and an ETF’s price will fluctuate throughout the day.
Mutual funds and index funds, on the other hand, are priced once at the end of each trading day — that price will be the same no matter what time you buy or sell.
Bottom line: This difference doesn’t matter to many investors, but if you want more control