IPO – Initial Public Offering

DEFINITION of IPO Initial Public Offering

IPO or Initial Public Offering is the abbreviation used to describe an initial public offering – the first sale of stock issued by a company.

WHAT IT IS IN ESSENCE

Prior to an IPO, the company is ‘private’ because its shares are only available to early investors.

In an IPO a company’s owners sell a portion of the firm to public investors. This is usually doing through an underwriting process that looks and acts a bit like a pyramid. The company negotiates a sale of its stock to one or more investment banks that act as an underwriter for the offering.

When a company embarks on an IPO, it lists a certain number of shares on a stock exchange in order to raise investment capital. IPOs are one of many ways in which companies are seeking to raise capital.

The other popular options are finding major investors, crowdfunding or using retained earnings.

HOW TO USE

After an IPO, share ownership is open out to the wider market. This is why IPOs have the title floating, flotation, or ‘going public’.

A successful IPO can raise huge amounts of capital. Becoming listed on a stock exchange helps to increase the exposure, prestige and public image of the company. This means that IPOs can increase the firm’s sales and profit in the future and give a more accurate valuation of a stock.

Pros

For traders, a float can be a great way of buying a share of a company. Or taking a position on its price trajectory the moment it hits the stock market. IPOs also increase liquidity on the market, which makes it easier for buyers and sellers to fill their orders.

But, when a company is listed on a stock exchange, it becomes subject to the rules. And also regulations of a governing body. This the moment when the company has to disclose financial information.  And this can be useful to competitors. 

Cons

For traders, it makes the analysis of a company and its share price trajectory much easier because information is readily available.

IPO make considerable costs to the company and require it to make itself fit for the public eye. If the market disagrees with the IPO price, the share price can go lower straight away. These risks can make floating costs.