IPO explained

• Updated

An initial public offering is when a private company sells shares for the first time

What is an IPO? Read on to find out – Photo: Shutterstock

An initial public offering (IPO) is the process whereby a company offers shares to outside investors for the first time, in exchange for funding to accelerate expansion. This is also called ’going public’.

Once this process is complete, the company is no longer privately owned. After going public, the company will need to follow strict rules and regulations, such as publishing information about the profits it has made and the tax it has paid.

Why do companies go public?

The amount of capital that can be raised through an IPO is staggering. Chinese e-commerce giant Alibaba smashed records when it managed to raise $25bn through an IPO in 2014. Other big-name IPOs you’ve probably heard about in recent years include Visa (which raised $19.7bn in 2008) and Facebook (which raised $16bn in 2012).

Going public on the likes of the New York Stock Exchange delivers greater visibility, prestige, an opportunity to hire talented employees and incentivise them through stock options, and chances to grow that wouldn’t have been possible otherwise.

Is it a complicated process?

Arranging an IPO can take a few months, and it can be an expensive journey for companies to take. Detailed documents need to be drawn up for investors and regulators that explain why the company is pursuing an IPO, what its current financial position is, and how ownership will be structured once the share sale is complete.

Investment bankers are used to manage the sale. Also known as underwriters, they play a vital role in helping a company decide how much each share should be worth.

Theoretically, a company can begin the process of entering into an IPO at any time. In practice, however, investors will be looking to see whether these firms are mature enough to go public – and they may need to hit a certain market value in order to remain listed on certain stock exchanges.

Are they good investments?

As with all other types of investments, there are risks for investors who try to get in on the “ground floor” and back an IPO on its opening day.

Some stocks can begin soaring in value as soon as trading begins. Other companies can overestimate their worth, and see their stock begin to fall sharply in the months that follow. One good example is the online discount retailer Groupon, which began trading at $28 but crashed in the year that followed, dipping below $5. The company’s share price has struggled to recover ever since.

Remember too that share prices can take a while to appreciate in value. Facebook shares started life at $38 in 2014, but managed to achieve growth of more than 400% a few years down the line.

Further reading:

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