IPOs are a way for companies to raise money by selling stock in their company to the public. A company wants to raise money and they want to raise it by selling stock. The easiest way to do this is to have the company sell stock to investors. If you think about this, you might think that IPOs are good. After all, if the company is worth investing in, then it will be a good thing for you to own some stock.

If you are unfamiliar with IPOs, it stands for Initial Public Offering. An IPO is a process used to publicly offer and sell shares of stock to the general public. The purpose is usually to raise capital for the company or to create a stable investment for shareholders.  If you are interested in this process and want to learn more about IPOs, then this article is for you!

An Initial Public Offering (IPO) is long and detailed. There is a lot of information to absorb before you become an industry expert and know everything there is to know about an IPO. To learn more about what this term means and how we can think about IPOs as investments, you can start by reading our blog post on the topic.

I can’t count how many times I thought. If I had invested in Amazon, Facebook, Tesla or (insert stocks that are booming here) in the beginning, I would have become a millionaire! !!? If you’ve had similar thoughts and want to benefit from the growth of promising new companies, an IPO gives you that opportunity. An IPO is the first public offering of shares by a company and can be an excellent opportunity to invest in growth. They used to be reserved for big investors (like hedge funds and pensions) with deep pockets, but many investment applications have made IPO stocks accessible and popular for ordinary investors. If you have a stock trading program like Webull or M1 Finance, you may receive regular alerts about new IPOs. You may be wondering what exactly IPOs are, whether they differ from common stocks, and whether they are a good investment. In this article, we look at the basics of an IPO, the process by which a company issues shares, alternatives to the traditional IPO process, and whether an IPO is the right investment for your portfolio. word-image-5748

What does IPO mean?

IPO stands for Initial Public Offering. This is the process by which companies issue new shares. It is also called an IPO because companies use this process to go from an organization with a few private shareholders to a publicly traded company whose shares are traded on national markets such as the NYSE or NASDAQ.

How does a business go from private to public?

When a business is formed, there are usually only a few owners – often only one or two. As a microcosmic example: When my husband and I started bottling and selling maple syrup from our family farm, we were the only ones at the helm. Like all small businesses, we were limited on time and money. It was not our intention to build a maple syrup empire, but if we had, we would have sought out people who would invest in our company in exchange for some shares (these people are called venture capitalists or angel investors). This would allow us to get more money to buy more bottles, buy a bigger kettle, employ more people, etc. so we can produce and sell more syrup. If our company is big enough (valuation around $1 billion) and meets other criteria, we could (with legal and marketing support from an investment bank) start creating shares for corporate and institutional investors, such as pension funds, mutual funds, hedge funds, etc. If we were to complete this lengthy process for our maple syrup plant, you could buy shares of Real Good Syrup on the New York Stock Exchange. (And yes, that was the real name of our company). In very simplified form, these steps look like this:

  1. After conducting due diligence, the company that wants to go public chooses an investment bank to assist it in the IPO process. The investment bank must file the required documents with the Securities and Exchange Commission.
  2. An investment bank builds up a book of contacts – it uses its contacts and marketing to attract and measure the interest of institutional investors to see how many of them want to buy shares in an IPO.
  3. The investment bank and the company set the price of the shares, and the investment bank agrees to purchase all of the company’s shares to finance the company’s IPO.
  4. The investment bank sells its IPO shares in the primary market (i.e., to institutions that have committed to purchase in Phase 2).
  5. The company’s shares can then be traded on a public exchange, such as the NYSE or NASDAQ.

Once these steps are completed, institutional shareholders sell their shares to the public, while ordinary investors can deposit them in their investment or retirement accounts. The whole IPO process can take six months to a year. Many companies are now looking for an alternative form of IPO, called SPAC, which shortens the IPO process. word-image-15901

Is a SPAC the same as an IPO?

The Special Purpose Acquisition Company (SPAC) achieves results similar to an initial public offering, but avoids many of the costs and regulatory oversight associated with a traditional IPO. SPACs have recently become a growing trend for companies looking to go public. These investments, often called net control companies, have raised $82.1 billion through 2020. Here is a simplified version of how SPAC takes a company public:

  1. A group of high-level investors (or sponsors) creates a shell company with no assets, products, or revenue. Their only goal is to take over another real company that is willing to issue shares.
  2. A SPAC registers with the SEC and proposes an IPO like an ordinary company. At this stage, SPAC generally does not have an acquisition target in mind.
  3. The money generated by the SPAC IPO will be held in a trust. They can only be used to acquire another business or, if no suitable business is found within two years, to repay the original investors.
  4. Once SPAC has identified a target company, the two companies will merge. The shares of SPAC will then be renamed into shares of the acquired company.

The main advantage of a SPAC is that the acquired company does not have to go through all the red tape required for a traditional IPO. This saves a lot of time and money, but also creates a less transparent perspective for investors. The original SPAC investors do not know what will happen to the company in the future, and post-merger investors do not have the regulatory oversight that the SEC has in a traditional IPO.

How can I invest in an IPO?

For individual investors like you and me, this can be a challenge. Most shares listed on the stock exchange are subject to purchase obligations by banks, brokers and investment institutions, and are therefore not accessible to ordinary people. However, recently online brokers and investment apps like Webull and Robinhood have reserved some IPO shares for interested and financially stable customers. A recent IPO filing by Figs (a medical wipes company) indicates that 1% of its Class A common stock is reserved for purchase by Robinhood users. Personally, I have received several IPO notifications in the past two years since I got my Webull app. When you place an IPO order in your investment app, there is no guarantee that it will be executed; you are merely indicating your interest in the stock. If the order is executed, it will be credited to your account on the effective date specified in the IPO notification.

Is an IPO worth investing in?

As with any action, you should research any company you plan to take public. Like all stocks, IPOs can lose value, and just because a stock went public doesn’t mean it’s a good investment. While this list is not exhaustive, you should at least know these few things before you start acting:

  • Why is the company selling shares?
  • What are they going to do with the IPO funds?
  • What is their income history?
  • What is the value of all their possessions? Your debts?
  • Is the leadership stable and competent?
  • What does the company’s competition look like? How do they add up?
  • What is the expected growth of the business?
  • How many shares does management own?

In short, all your qualitative and quantitative research should indicate that the company is ready to grow (in a new market, with a new product, etc.) and is using the IPO to accelerate that growth. If the company is using the funds to pay off old debts, look for another investment. In the first few weeks or months, IPOs can be very volatile (i.e., they can rise or fall quickly). Because if the stock is brand new, it is very difficult to price reliably. Such volatility is attractive to some investors and unattractive to others. You need to weigh this volatility against the rest of your portfolio and your own risk tolerance to decide whether IPOs are a good investment for you. Personally, I have not included any IPOs in my portfolio. I prefer more reliable, turtle-like investments like index ETFs and mutual funds. Passive investing requires much less time and energy for research than an IPO. Granted, I may be missing out on some top new companies that will skyrocket, but I’d rather sleep peacefully knowing that my capital is growing in proven companies than betting on the new entrants to the market.

How can I determine whether investing in IPOs is for me?

Because of their volatility and the involvement of new and unproven companies, IPOs fall into the category of risky and speculative investments. This is not where you should invest your emergency or retirement savings (or at least not most of it). But if you and your portfolio can handle the risk, you can achieve amazing returns. Facebook’s IPO was worth $32 a share, now it’s worth literally ten times that. Amazon’s IPO cost just $16, and at the time of writing it is worth $3,244, not counting the three splits it has undergone in that time. If you have the knowledge and time to learn about IPOs, and the patience to see them through to completion, your efforts can be well rewarded.

Before you get into complex forms of investing such as IPOs, you need to familiarize yourself with some of the basics of investing in stocks. Here are our favorite proven investing tips that apply to beginners and experienced investors alike. First, determine your investment goals. Before considering stocks, look in the mirror and decide what you want from an investment. Ask yourself the following questions:

  • Is it fake money you want to raise for fun?
  • Is investing in stocks a way to grow your savings outside of a traditional bank account?
  • Are these pension funds you would like to receive in the future?
  • Are you a risk taker or do you tend to make emotional decisions in times of financial difficulty?

The answers to these questions clarify your investment objectives, which become the guide for your financial decisions.

  1. Determine how much you can invest. Personal finances are just personal finances, so we won’t mention dollar amounts or even percentages here. It’s all up to you. But the money you invest grows and the money you spend disappears. So make a budget and systematically put what you can into your investments.
  2. Choose investments based on your objectives. If you are young and have plenty of time to grow your investments, you need to balance risk and return to build a portfolio that is aggressive enough to generate the long-term returns you desire. If your time horizon is short, choose conservative investments that are unlikely to lose value.
  3. There is a demand for this. Investment applications give you all the research, trading capabilities and flexibility of a traditional stockbroker and eliminate almost all trading costs. Most offer fractional shares, educational content, and specialized investments like REITs, cryptocurrencies, and options. (Personally, I use Webull in particular).
  4. Promotions offer unique opportunities. Equities are one of the most diversified, current and profitable investments for the average investor. They are easy to buy and sell and offer consistent positive returns over the long term. Most investors have stocks in their portfolios. (Want to know more about how to get started with stocks? Check out our handy guide for beginners).

Baseline

Going public offers the opportunity to ride the wave of a young company from the start, to (hopefully) benefit from future periods of rapid growth. However, not all IPOs produce such returns, and many lose value in the short and long term. Remember when I said Facebook was offering a 10x return to IPO investors? This only happened when the stock lost almost half of its value in the first year. If IPO stocks are available through a strong relationship with a traditional stockbroker or an investment app like Webull or Robinhood, do the same research as for traditional, established stocks. Remember: Just because something is shiny and new doesn’t mean it has value.

Read more:

word-image-15902IPOs—Initial Public Offerings—are a form of secondary stock sale that are made public by a company wishing to raise money (for example to finance a new product or to expand its business). They can be a bit risky, since stock prices can fluctuate greatly during the initial offer and auction process. The key to investing in IPOs is to do your research to understand how the process works, and to decide if you feel comfortable investing in the company.. Read more about can you buy and sell an ipo in the same day and let us know what you think.

Frequently Asked Questions

Are IPOs a good investment?

The past few years have been the best time for the last decade to buy stock in public companies. The market has been hot, the economy is strong, and companies are able to raise money swiftly. But with the recent market meltdown, will IPOs be destined for the same fate as the subprime mortgages that were folded into mortgage backed securities? The modern IPO has a long and storied history. The first IPO occurred in the United States in the late 19th century when the New York City-based brokerage firm of Hutton & Co. floated a share of its stock. The first share ever sold for $100, and the first person to buy it was a poor baker named Cornelius Vanderbilt. The stock was later quoted on the New York Stock Exchange (NYSE) in the 1890s. Today, the practice of selling shares of stock to the general public through an IPO is a huge part of the modern-day U.S. economy.

Why should you invest in an IPO?

In the past, when companies have gone public, they have raised money by selling shares of their stock to the public at a price set by the company’s board of directors. Now, companies use the “IPO” system to raise money by selling shares directly to investors. In the last few years, we’ve seen a dramatic increase in the number of initial public offerings (IPOs) in the U.S. and around the world. In fact, last year, we saw record IPOs with $77 billion raised. While this increase in the number of IPOs may have an impact on an individual investor’s portfolio, it doesn’t have to be a detriment.

Is it good to buy stock at IPO?

Public companies are valued based on their future expected profits, and IPOs are a way to determine if that future is worth investing in. However, many companies go public with little warning. This creates an opportunity for investors to snap up shares at a discount, then sell them at a higher price later. Whether you should invest in this discounted stock, and if so, when to sell, depends on how much risk you’re willing to take. On the one hand, we can say that it is poor form of professional finance to invest in business stocks that have yet to start trading. On the other hand, many people don’t have enough money to live on for the next 10 years, or until their stock options expire. So, is it really bad to buy stock at an IPO?

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