What Is An IPO? How Can You Invest In One?

By Saroni Chakravarti | November 23, 2019

If you follow financial news, you must have come across the term “IPO” quite frequently. So, what does it really mean? Let’s find out.

If you follow financial news closely, chances are you’ve come across the term “IPO” quite frequently. Every now and then, companies announce that they’re going public and listing on stock exchanges. In recent times, WeWork came in the news for their IPO filing that later blew up in their faces when scrutiny of their paperwork revealed that they had a shaky financial standing.

So what is an IPO? What does it mean and should you invest in one? Let’s take a look.

What Is The Meaning Of IPO?

An “IPO” or Initial Public Offering is when a company decides to go public or list on a stock exchange. What does this mean? When companies reach a stage when they are profitable, they often decide to go public. This means that a hitherto private company starts issuing stocks to the public on the stock market. Once a company goes public, its status changes from a private company to a public company.

What is the difference between a public and a private company? The difference lies in how the shares of the company are held. In a private company, the shares are held privately, whereas in a public company, the public wholly or partly buys the shares on the stock market.

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Why Do Companies Opt For An IPO?

When companies become profitable, to further their growth, they file for an IPO so that they can raise more capital. When a shareholder is buying stocks, they are offering the company capital. The company can then use this capital to fund its growth and expansion. An IPO also offers the opportunity to the founders and initial investors of the company to “cash out”. In fact, if the company has a promising first-day IPO performance, some of these initial investors and founders may even become overnight millionaires.

While an IPO may help a company raise more capital to fund its ambitions, filing for an IPO brings with it its fair share of scrutiny and public exposure. Companies have to abide by several regulations and have squeaky clean paperwork and financials in order to be approved for an IPO debut. An IPO can also give a company tremendous exposure that can help boost its performance on the market.

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What Are The Risks Of An IPO?

So, do all companies opt for an IPO? Not really. That is because IPOs are accompanied by a lot of paperwork and hassles. For instance, when a company files for an IPO, it comes under a great deal of scrutiny. Regulators comb through financial statements and perform rigorous checks on the paperwork to see if the financial standing of the company is as what the company claims.

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Besides this, IPOs are also expensive affairs. In the run-up to the IPO, the company has to spend loads of money on underwriters, lawyers, auditors and registration fees. Once the IPO is filed, the company has to abide by several regulations and disclosures which not only force them to be more transparent, but also involve high administrative and labour costs every year. When the company goes public, the founders and initial shareholders of the company also have to cede control of the company. Thus, after the IPO, the pressure to meet targets may increase.

Companies, thus, must consider carefully the pros and cons before deciding to opt for an IPO.

How To Invest In An IPO

The stock market is full of vagaries and if you have little to no experience of investing, you should do thorough research and groundwork before diving into it. The company filing for the IPO issues a prospectus that contains all the crucial financial details that you will need to make up your mind. This includes the amount of money that the company is planning to raise through the IPO and how it’s planning to use it. This should help you make an informed decision.

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Risks And Rewards Of Investing In An IPO

When you buy shares of a company that has recently filed for an IPO, you become one of the first shareholders of the company. This means that you get shares at lower prices, and if the company flourishes, the share prices spike too and you get a good deal.

When you’re investing in the stock market, risk also forms a crucial component. Your returns are contingent upon the performance of the company. For instance, if the company fails to grow and expand over time, you stand the risk of losing your money. Unlisted companies do not have to publish their financial reports and statements, so there’s no way you can check their past performance while subscribing to their shares.

The prospectus of the company does reveal the financial track record of the company and you can refer to that to carry out due diligence on projected performance and figure if the IPO is in line with your expectations. However, one thing that you should bear in mind is that past performance does not guarantee future performance.

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