An Initial Public Offering, or IPO, is when a private corporation makes it’s stock available to the public for purchase. IPOs are hot items in the news recently. In this article, we will go over the basics of what is involved in an Initial Public Offering and whether investing in one will be right for you.
Very basically, an Initial Public Offering is when a private corporation makes its first issuance of stock available for public purchase. For corporations, this is a form of raising capital and allows the initial private investors to realize gains. IPOs are complex processes and typically get started long before anyone gets wind of it in the media.
Corporations usually begin the process when they reach a $1 billion valuation and they feel they can now handle the responsibilities of SEC regulation and public shareholders. While some companies do have IPOs with lower valuations, it is less likely. They must have strong proof of profitability and show they can meet the listing requirements.
The Road to an IPO
The road to an Initial Public Offering can be broke into five general steps. These are:
- Various underwriters present proposals to the corporation.
- The corporation chooses the underwriter with the proposal they thought was best and they both enter a contract.
- All the pertinent corporation information is compiled, and the necessary documentation is completed. The main document for this process I the S-1 Registration Statement, which is filed with the Securities and Exchange Commission (SEC)
- The corporation will also make marketing materials to advertise the future issuance of their new stock. During this time the underwriters will determine the final offering price and complete the last SEC requirements.
- Once all the necessary documentation is approved and finalized the company will issue the new public share on the preset IPO date.
Advantages and Disadvantages
As with any type of investment choice, there are both advantages and disadvantages to IPOs. Each corporation has to take these into consideration to see if an Initial Public Offering is the right step for them. Some of the advantages include:
- The ability to quickly raise large amounts of capital through the public investing in a stock.
- The transparency of a public company can make it easier to get loans with favorable terms.
- They have the opportunity to raise additional capital by doing a secondary offering.
The disadvantages of an IPO include:
- IPOs involve high expenses and will require large sums of money for upkeep.
- The level of disclosures required may mean that a corporation must reveal business methods they would prefer to keep quiet.
- Current shareholders will lose some control due to new shareholders who may gain voting rights.
Each corporation will have to determine if an initial public offering is a good move to help them grow their business.
Investing in an IPO
When you are thinking about investing in an IPO there are some things you should take into consideration. First, the headlines should not be your main resource. The prospectus should be your main guide, followed by your trusted investment advisor. Second, many people view IPOs as a way to guarantee quick growth, due to the huge increase in interest. But remember, there is always a level of risk with each investment that you make. Lastly, you need to take into consideration if this choice really fits into your portfolio, or if you are just being caught up in the news reports. If you carefully take everything into consideration you may be able to make a wise investment that helps you diversify your portfolio.
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