What is an IPO? Your 101 guide to public debut

Summary

  • Initial Public Offering is becoming increasingly popular across the world.
  • Retail investors can also access IPO shares, and it is becoming a more democratic process now.
  • Find out if it is good or bad to invest in an IPO.

The transformation of a privately held company into a publicly traded company is known as the initial public offering (IPO). When a private company opts for an IPO, it sells new or existing securities to the investors for the first time.

There are limited stakeholders or accredited investors in a private company who invest when the company is relatively new in the business or secures funding for expanding the business operations. But when it comes to a public company that gets listed on a recognized stock exchange, there can be many stakeholders as numerous shares are available for purchase at the time of public debut.

Before an IPO, a company strictly keeps its business matters secret. However, a publicly listed company shares financial details and other relevant documents so that the investors know the accurate picture of the company's status and business activities.

Who can buy pre-IPO shares?

Traditionally, in an initial public offering, it is the institutional investors or company employees or high net worth individuals preferred by companies to offer their pre-IPO stock. This happens because the primary goal of a private company is to raise capital by selling shares.

Institutional investors are preferred as selling a million shares to a person, or an entity is convenient and efficient than selling those shares to 500 or 1000 individuals for the same amount.

If you are a retail investor, then you are last on the ladder. However, that doesn't mean that you cannot access pre-IPO shares. For example, a retail investor can set up a trading account with a brokerage company to select the number of shares or the minimum amount of shares the company wants to sell.

After paying the amount for the selected quantity of shares, the retail investor can be allotted those shares through a computerized process that maintains transparency and allocates shares to retail investors impartially.

Why does a company go public?

Firstly, a private company opts for a public debut to raise money and expand its business operations. Every company requires a lot of money to expand, develop new products or strategies and pay off the existing debts. Instead of taking huge loans, going public is a great way to raise the much-needed capital.

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Secondly, an IPO allows accredited investors or venture capitalists to exit. A private company becomes liquid by selling shares in the market, and initial investors sell their stake in the company to earn money and exit from the company.

Thirdly, the public debut is much hyped and allows the companies to get publicity for their products and services.

Advantages of investing in an IPO

Investing in an IPO allows the investors to act early as the company sells shares for the first time. Acting early allows investors to get hold of the shares and get immediate benefits in a brief period, as often the listed shares open at a higher price at the time of public debut.

Buying pre-IPO shares also have the potential to give returns in the longer run. As companies opt for public debut to raise capital and expand their business operations further, a company can make huge profits in future, and shareholders can benefit from it.

Disadvantages of investing in IPOs


Before you decide to invest in an IPO, it is essential to understand the disadvantages also. It is important to note that investing in an IPO requires a lot of time as investors need to read and study the prospectus filed with the regulatory authorities.

Another disadvantage is the risk associated with selling shares. Many investors want to buy pre-IPO shares because they want to sell them immediately after being listed in a stock market. However, sometimes buyers of those shares are immediately unavailable, and it might become difficult to sell them immediately.

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Key terms associated with IPOs

  • Underwriter

Underwriters are typically big banks involved in a public offering of a company. Their role is to determine the company's share prices, allotment of shares, and publicize the IPO.

  • Issue price

Often dubbed as offering price, the price at which the shares will be sold to the investors before the company starts trading on stock exchanges like the Toronto Stock Exchange in Canada.

  • Common stock

When a private company starts trading as a public company on a recognized stock exchange, it offers common stock for sale. This means that a common stock represents common shares of a company that allows investors to vote on company matters and receive dividends.

  • Preliminary prospectus

Before going public, a private company files a preliminary prospectus comprising financial and operational details of the company. For example, a company must file their preliminary prospectus with the US Securities and Exchange Commission to list its shares publicly in the US.

  • Offer Date

The day when you can apply for shares in an IPO is known as the offer date. In simple words, the offer date can be described as the opening date of a public debut.

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