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Understanding A IPO – The Initial Public Offering

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Introduction

 

 

Stocks is a commodity that is highly liquid an is one of the most popular investments due to their growth potential and liquidity. Companies use the desires of shareholders to their advantage as this allows them to use the money generated by issued stock to pay off debts, and expand their companies – and in return, they are able to pay these valued shareholders in the form of a dividend – a win win situation. But where does this process start and how do companies issue stock in the first place? In today’s lesson, we will be covering the process of how companies issue stock – as this will help your understanding of a IPO or Initial Public Offering.

 

But before we begin, we would like you to read and agree to the Terms & Conditions of this post before you proceed any further.

Disclaimer: Invest In Wall Street is in no way financially or legally responsible for any investing decisions made by any of our readers and are, in turn, acting on their own free will. The information in this article is purely educational and should not be abused or misconstrued in any way, shape, or form.

 

 Understanding IPOs

 

 

An IPO or Initial Public Offering, is the initial sale of a company stock to the public. Prior to the IPO, company stock is privately held and cannot be sold to the public.

Startup companies may go public to raise money to develop and grow their business. Other companies may go public to expand existing products or services.

There are some other advantages to going public. Companies can raise capital without increasing debt, and allowing existing shareholders to profit from company growth by liquidating their shares.

 

 

But on the flip side, public companies have increased reporting requirements, and additional marketing, accounting, and legal costs.

So how exactly does a company go public?

First, a company gets the help of an investment bank to underwrite the public offering of shares. This means they set the price for how much each share sells for.

In turn, the underwriter gets a commission on the sale of these shares. Often, the lead underwriter will gather other investment banks into a syndicate – allowing more institutions to get involved.

The company, along with the underwriting syndicate will develop a prospectus, a report, detailing the specifics of the offering, and will register it with the SEC – and then get purchase commitments from institutional investors, brokers, and other banks.

These groups then make the shares available generally to high value customers, typically in exchange for holding the stock for a period of time.

This placement of shares is the Initial Public Offering. Once the IPO is complete, shares start trading on the stock exchange. It’s here that the stock price is determined by market force, not the underwriters or the company.

Often there is a great deal of excitement driving buying and selling. Investors interested in participating in the initial placement should check with their broker for share availability.

 

 

 

But for the average retail investor, buying shares at the offering price, before the stock starts trading is difficult – as most will have to wait until it trades on the stock exchange.

The lack of previous trading history, limited company information, and initial price volatility makes trading IPOs risky, and the risk of loss is substantial.

But with the risk of loss comes the potential for profit as well. And this potential is one reason many traders pay so much attention to IPOs.

 

 

Quick Recap

In Review…..

Initial Public Offering (IPOs)

  • An IPO or Initial Public Offering, is the initial sale of a company stock to the public. Prior to the IPO, company stock is privately held and cannot be sold to the public
  • Startup companies may go public to raise money to develop and grow their business. Other companies may go public to expand existing products or services
  • There are some other advantages to going public. Companies can raise capital without increasing debt, and allowing existing shareholders to profit from company growth by liquidating their shares
  • But on the flip side, public companies have increased reporting requirements, and additional marketing, accounting, and legal costs

Launching A IPO

  • First, a company gets the help of an investment bank to underwrite the public offering of shares. This means they set the price for how much each share sells for
  • In turn, the underwriter gets a commission on the sale of these shares. Often, the lead underwriter will gather other investment banks into a syndicate – allowing more institutions to get involved
  • The company, along with the underwriting syndicate will develop a prospectus, a report, detailing the specifics of the offering, and will register it with the SEC – and then get purchase commitments from institutional investors, brokers, and other banks
  • These groups then make the shares available generally to high value customers, typically in exchange for holding the stock for a period of time
  • This placement of shares is the Initial Public Offering. Once the IPO is complete, shares start trading on the stock exchange. It’s here that the stock price is determined by market force, not the underwriters or the company
  • But for the average retail investor, buying shares at the offering price, before the stock starts trading is difficult – as most will have to wait until it trades on the stock exchange
  • The lack of previous trading history, limited company information, and initial price volatility makes trading IPOs risky, and the risk of loss is substantial
  • But with the risk of loss comes the potential for profit as well. And this potential is one reason many traders pay so much attention to IPOs

 

 

And this is the general process of how stocks are created – the life of a stock so to speak. A company may opt to become incorporated and launch a IPO to generate revenue without going into debt – in order to build and expand their company – but once a company goes “public”, the company is no longer owned by the presidents, CEOs, CFOs, and other administrators of the corporate round table – but is instead, owned by all who invest in their stock – such as YOURSELF.

Although it should be noted that once the process is completed, it may be harder to acquire the stocks on New Issue Day – as most brokers may not have access to them just yet. This is why it is important to keep tabs on companies that are looking to launch, as it allows you to plan ahead of time but most importantly, determine whether a company is worth the investment. After all, they are now entering the market and there is no financial reports you can use for fundamental analysis and it’s hard to predict how shareholders will react to the stock itself.

This doesn’t mean to say that they are not worth the investment – since the most notable companies that you all know today like Disney, Facebook, Twitter, Apple, ect. – have ALL gone through the exact same process. There once was a time long ago, where investors were unsure of whether to invest in these now infamous companies because they were RELATIVELY NEW.

This of course ultimately boils down to whether you see any potential in a particular company and whether you think that there is room for growth – which equates to greater capital gains.

I hope you have enjoyed this post and found the information to be quite useful. If you have any questions or concerns, please feel free to leave them down in the comment thread below and make sure to like and share this post.

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