The basics of initial public offerings.
A stock is a percentage of a company. When buying a stock, also known as an equity, an investor is buying a piece of the company as a share. The share price of the company is based on how much the company is estimated to be worth and how many shares are being issued. When the share is bought, the company gets to keep the money made while the share continues to be sold on an exchange.
What is an IPO?
IPO stands for initial public offering. This is the first sale of the stock issued by a company to the public. Before the IPO step, a company is considered private. There aren’t that many shareholders when the company is private, usually consisting of early investors (which are the founders and their network of friends and family) and professional investors, like venture capitalists or angel investors.
When stocks of the company are offered to be purchased by the public, it starts the journey as an IPO. The public is everyone else who wasn’t involved in the earlier stages of the investment process. An IPO is also referred as “going public.”
When a private company goes public, it gives up some of its benefits. This is why many small and medium businesses choose to stay private. One benefit of being a private company is not having to disclose much financial or accounting information about the company. Luckily, it is relatively affordable to run a private company. Large companies can also be private. IKEA and Hallmark are good examples of large companies that never went public.
If companies can run successfully without an IPO, why wouldn’t they?
A lot of money can be raised when going public and it allows the company to grow and expand. Though there are ways for private companies to earn money, the IPO option is the best and easiest way to raise large amounts of money for a company.
A lot can happen financially for a company that goes public. For one, due to increased scrutiny from investors and financial analysts, public companies have lower and more favorable interests rates when they issue debt. Also, if there is high demand for a company, a public company can issue more stock in a secondary offering.
IPOs are attractive for investors as well. Trading on an open market means liquidity. Shareholders of private companies find it difficult to sell their shares and value their shares. There are ready buyers on the stock market with known price and transaction data.
How a Company Goes Public
A company cannot just decide one day that it is going to go public and begin selling shares on the public market. There are many steps that have to take place first.
Before the process, a company thinks carefully and analyzes that the IPO option will maximize the returns of early investors and raise the capital it needs to succeed. This means that there are already prospects of growth when the IPO decision is made, with investors waiting to buy some shares. Those who are directly given the IPO are able to buy it at the IPO price, usually much less expensive than the market price.
To do this, the company hires an investment bank that underwrites the process via debt or equity. This is like a broker that stands between companies and the investing public to sell and market the initial shares. Before the company can do that, however, it must meet certain criteria.
The company’s management and team should be able to:
- Guide the company once it’s public, growing the company’s business with an eye to the public marketplace
- Obtain audited financial statements using IPO-accepted accounting principles
- Develop proper corporate governance, including an independent board of directors and qualified officers
- Time the IPO decision to take advantage of favorable IPO windows
Investing in an IPO
IPOs allow the public to invest in and profit from the growth of a company. Many investors are finding that IPOs are a great way to make money, but it’s not for those looking to make a quick buck. The focus of IPOs now is long-term investment.
Many experts say that investing in IPOs can be risky by nature. Here is some advice:
Do your research– Make sure you get as much information on the company as you can, which can be difficult when the company is in the planning stages of going public. Researching the company, competitors, press releases from the past, and overall success can be a good first step.
Choose a company with strong brokers– A company with a strong underwriter and investment bank is generally trustworthy, though that’s not guaranteed. Be careful with companies with smaller, unknown brokerages.
Be cautious– If you feel something is off, chances are it is. There is a lot of uncertainty surrounding IPOs, mostly due to lack of information.
Alpenrose as an SEC-Registered Advisor
Alpenrose Wealth Management International AG, the sister company of Alpenrose Wealth Management AG, is now a registered investment advisor with the U.S. Securities and Exchange Commission (SEC). Together with our partner Swiss private banks, our company can now offer the full Swiss private banking experience to American clients, both resident and non-resident.
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