What Does IPO Mean?
An initial public offering (IPO) is a company’s 1st entry into the public stock market. Sometimes referred to as “going public,” a company’s IPO allows it to raise capital by offering private shares of stock to investors on a public stock exchange.
Investing in an IPO has the potential to provide you with attractive returns. However, IPO investing doesn’t follow the exact same process as investing in an already-established company — so it’s important to do your research before you dive in. Our guide to IPO investing and the process a company needs to go through before going public will help you invest in upcoming IPOs more effectively.
Initial Public Offering (IPO)
An IPO is the first opportunity that institutional investors and retail investors (the general public) have the opportunity to invest in a company’s newly issued stock. Prior to an IPO, a company is privately owned. After an IPO, owners of a company give up a portion of their investment in exchange for shares of stock, which represent the percentage of the company that they own.
Companies might operate as private entities for years before making the decision to go public. For example, although the ridesharing app Uber has been operating since 2009, the company only decided to go public in 2019. Companies typically decide to offer an IPO to pay off debt or raise funds for a new venture.
Why would a company want to make an IPO? There are both advantages and disadvantages that come with making the decision to transition from a private company to a public one. Some advantages of going public include:
- Enhanced ability to collect capital: When you buy shares of a company’s stock, you provide the company with capital it can use to fund new projects without the risk, restrictions and debt that come with seeking venture capital. This allows companies to raise a large amount of money very quickly.
- Improved advertising abilities: In addition to raising more money for enhanced advertising opportunities, IPOs can also attract public attention. Publicly traded companies also tend to have more success in attracting talented management professionals and top-tier personnel with stock options.
- More trust with investors: To qualify for an IPO, a company must undergo regular audits and submit security and income documentation to regulatory bodies like the U.S. Securities Exchange Commission (SEC). This can increase public trust among investors by providing a more transparent look into a company’s finances.
Going public may also come with disadvantages, including:
- High upfront costs: Qualifying for an IPO is not an easy or inexpensive task. Before a company can go public, it needs to submit a wide array of paperwork and documentation that requires a team of lawyers, investment bankers, consultants and more to create. A poorly timed IPO can eat up a significant chunk of change that could have otherwise been put toward projects aimed at growth.
- Increased financial reporting standards: Even after a company launches its IPO, it must submit regular financial data to regulatory bodies, which then becomes public information. Public reporting holds executives to higher standards and allows shareholders to quickly access an intimate picture of a corporation’s financial health. In some cases, this may lead to a shareholder lawsuit if a company was mismanaged.
How an IPO (Initial Public Offering) Works
Investing in an IPO is a relatively simple process. If you’ve invested in stocks or mutual funds before, you’re probably already familiar with the process of placing an order through your broker to purchase shares of stock. However, the IPO investing process does vary a bit when compared to purchasing stock that’s already had its initial offering.
First, you’ll want to research upcoming IPOs. When a company meets all the criteria to go public, it will announce a date for its IPO, as well as an offering price. You can view a list of upcoming IPOs here. Set an alarm for the date of the IPO that you’d like to buy, as you can begin investing at the specified IPO announcement date.
The offering price isn’t necessarily the amount of money you’ll pay to purchase a share of the company’s stock. Offering prices are limited to a fixed number of investors, including the company’s employees. These investors’ orders are filled before the opening bell rings, which means that the market price of each share can rise dramatically before you get a chance to place an order. For example, when retail investors were able to access Snapchat’s stock during its IPO, prices had already risen over 40% above the company’s offering price. Know how your IPO’s pricing is changing throughout the day to avoid accidentally overspending.
After you know what you want to purchase, you’ll need to open a brokerage account that supports IPO investing. You’ll typically be able to use your current brokerage account if you have one. However, due to high demand, some brokers may limit who is allowed to participate in upcoming IPOs.
If you don’t have a brokerage account, we’ve included a list of our favorite brokers supporting IPOs below. Here’s a brief guide to investing in stocks if you’ve never bought or sold a share before — you’ll want to brush up on the basics well before the date of the IPO you’re interested in arrives.
On the date of the IPO, you can invest as soon as the stock goes public through your broker. Be sure that your account is funded and cleared before the opening bell. After you place an order and your order is filled, congratulations! You’re now among the first partial owners of a newly-launched public company.
Why Are IPOs Important to Traders and Investors?
IPOs are important because they represent a company’s commitment to future projects and transparency. Companies that qualify for an IPO must meet strict financial auditing and documentation processes that allow investors to fully understand exactly what they’re investing in and to make accurate judgments on which companies are actually worth their investments.
Being authorized to announce an IPO is an achievement in and of itself, simply because companies need to already have enough funding to hire lawyers, investment bankers and public relations specialists needed to ensure a successful launch. Unestablished companies and those that don’t have enough capital to be approved for an IPO rarely make it to the stock exchange. By investing in publicly traded companies, you have access to investments that have met SEC criteria, which can help you protect your trading funds when compared to alternative investments.
Example of a Recent IPO
If you work in a remote collaborative environment that tracks a series of projects simultaneously, you might already be familiar with the New York Stock Exchange’s most recent debuts, Asana Inc. (ASAN). The company produces a series of management and collaboration tools that teams working remotely can use to assign projects to one another, track statuses on deliverables, communicate and more.
Asana was launched in 2012 by a team of ex-developers from companies like Facebook and Google. In 2018, Asana was worth an estimated $1.5 billion.
In August 2020, Asana applied for an IPO to move the structure of the corporation from a private to a public company. The collaboration software received its approval, and Asana’s IPO was launched on September 30. The company’s offering price was set at $21 but quickly reached $28 on the date of the IPO. Asana shares are currently trading around $23 on the NYSE.
Launching an IPO isn’t a simple process for any company. Companies must go through a series of financial auditing and underwriting processes before they may sell shares to public investors. These standards are regulated by the SEC under the Securities Act of 1933.
The IPO process typically consists of 5 steps:
- Banking selection: A corporation must first partner with a licensed investment bank to assist in launching its IPO and completing regulatory checks. Companies select a bank based on its fees, reputation, history of launching successful IPOs and more. Banks put together groups of buyers and create a plan to ensure that shares are sold at a select price in exchange for a commission.
- Due diligence: After the company chooses an investment bank, the bank will draft a series of underwriting documents detailing the company’s history and plan for its initial offering. The bank then submits these documents to SEC officials.
- Pricing: Once the documents are approved by the SEC, the company and the bank work together to choose an offering price. Many IPOs are intentionally underpriced to attract buyers when the date of the IPO arrives.
- Stabilization: Once the IPO launches, the underwriting bank ensures that all shares of stock laid out in the due diligence documents are sold. If the bank cannot secure sufficient buyers, it may purchase shares itself.
- Transition to market competition: Once all shares of stock are spoken for, the volatility of the stock begins to cool as it enters the market competition stage. Six months after the IPO, inside investors are free to sell their shares as they please.
Invest in an IPO
Are you ready to start investing in IPOs? The 1st step is to open a brokerage account. If you don’t already have an account, consider a few of our favorite brokers below that offer access to IPO investing.
Getting in Early with IPOs
Though IPOs can be rewarding for investors, it’s important to remember that just because a company makes it to the IPO stage doesn’t guarantee success. With a lack of trading and financial history, it can be difficult to predict how a company will do in the future. Share prices also have a tendency to spike on the date of the IPO when excitement is high. If you plan to invest in an IPO, make sure you do as much research as possible before the big day arrives.