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If you read investment or business news, you’ve heard a lot of excitement around IPOs, but you may have wondered, exactly what is an IPO?
IPO stands for “initial public offering” and it represents the first time a company becomes publicly traded, offering shares for purchase via a public stock exchange. In the United States, public stock exchanges include the New York Stock Exchange (NYSE) and National Association of Securities Dealers Automated Quotation System (Nasdaq). Other exchanges are located in various cities, including Boston, Chicago, Miami and Philadelphia.
NASDAQ says that the primary purpose of an IPO is enabling a company to secure capital for the company’s future growth.
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Steps in Making an Initial Public Offering
If you are an entrepreneur who has successfully built your company, you can choose to take your privately held company to the public by making an Initial Public Offering. Your first step, after making this initial decision, is to secure an underwriter. Underwriters are typically banks that help the company form its prospectus, which is a document provided to investors. The initial prospectus usually only provides just enough information to get investment interest. The amount of interest following the prospectus determines the number of shares that will be offered, and the initial investment price. The final prospectus gives all necessary investment information, and is filed with the Securities and Exchange Commission, and a date for the initial offering is set.
What Happens on the IPO Day?
Major investors will usually be offered the opportunity to buy the IPO company’s stock early on the day the first public stock offering occurs. Later on in the day, the IPO is opened for general investors. A successful initial offering means that the company’s initial price holds during the course of the first day. If the stock value goes down on that day, that usually means that the underwriters put too high a value on the initial offering.
Initial Public Offering Investment Theories
Nothing is more exciting to some investors than the thought they could get in on a really successful company’s stock on the first day. The reality is often different. Some investment advisors warn their clients away from IPO “fever,” citing flops and failures including FitBit and GoPro. Others favor IPOs, pointing out how much money people who invested on the first day for companies like Amazon, Facebook and Google have made over the years. “Know your IPO well” is probably the best advice for investors, because the majority of new companies see a buildup of excitement and investment, only to have stock value drop over six to eight months after the initial offering day.
With the tendency for IPOs to see downturns after an initial burst of activity, the majority of investment gurus wait to evaluate a new public company’s stock over time before pronouncing the company a failure. “Big fish” investors also have many advantages in the process including getting offers to buy before the general public. According to Investopedia, there haven’t been huge stock price gains on the first day of an IPO since the “dotcom” era of the 90s. If you recently wondered what is an IPO, study of the market and how companies become public before committing any investment dollars is a great idea.
