IPOs – Initial Public Offering

With the coverage of the Facebook IPO, the previous LinkedIn IPO, Zynga, I wanted to write a follow-up post covering all aspects of IPOs including what they are, how they work, and how an investor can profit from them.

What are IPOs?

An IPO, or Initial Public Offering, is the first time a company sells its stock to the public on the public markets i.e. Stock Exchanges.

They can be undertaken by companies of any size small to large, and let the company raise funds for activities such as, expansion, research, development or to improve its public image.

When a company decides it wishes to float its stock, it will employ the services of a investment bank(s) to act as a bookrunner, frontrunner or underwriter. A favoured bank will be chosen to fully run the IPO process from start to finish.

The chosen bank will receive a fee for its services, either fixed, or a percentage of the proceeds raised.

Advantages/Disadvantages of an IPO

These can include:

  • Improving and diversifying equity base
  • Access to cheap capital (for the reasons mentioned earlier)
  • Prestige and public image
  • Attracting superior employees
  • Being able to make acquisitions

Some of the disadvantages are:

  • Larger accounting, legal and marketing costs
  • Requirement to publicly disclose finances and business details
  • Competitors have access to material information
The IPO was be announced usually through an S-1 filing which details the company’s plans to access the public markets. There are a number of press conferences by management and coverage by research divisions of investment banks to access the strength of the IPO, what the value of the company and the stock price should be.
If the company was previously trading on a secondary exchange such as secondmarket.com, it will no longer trade.
On the IPO day, the underwriter will usually try to make the stock price pop, rise 10-20% or even more, as that makes a good public appearance.
Employees, management, and institutional investors who have access to stock will usually be restricted from selling the stock for at least 6 months and even upto 18 months.
For more info visit investopedia.com
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