The term IPO stands for an initial public offering. In layman’s terms it means the first time a private company will sell shares to the public. Doing an IPO or going public is a great way to raise capital for firms and has many benefits. Below are some of the benefits to a company that participates in an IPO.
- Costs involved with IPO are much less than the cost of borrowing.
- Company does not have to worry about repayment like borrowing, because capital raised does not have to be repaid.
- Several factors not related to the company like market conditions, negotiation, and analysis can lead to a higher offering price which means the company will raise more capital.
- The firm is able to enlist the support of a large group of investors who give their money in return for a future return on investment.
Once a company makes the decision to do an IPO, it must register the offering with SEC by filing a registration statement, which is usually done with Form S-1. That registration statement will get reviewed by the staff of the SEC to make sure it has the necessary disclosure documents. The review process is not intended to determine the merits or appropriateness of an IPO and at its conclusion the registration statement becomes effective and the company may continue with the IPO.
Since the company participating in the IPO used to be privately held there will not be as much information available as the companies who are already public, but research is still important. Any information filed during registration, and any subsequent amendments will be on file with the SEC in their EDGAR database at www.sec.gov/edgar/searchedgar/webusers.htm. Other important information that can influence the buying decision of the company going public can be found in the prospectus. There are many important sections in a prospectus to consider, below are some that are highlighted in the SEC’s Investor Bulletin titled Investing in an IPO.
Requirements to buy an IPO
Before you can participate in an IPO you have to answer a series of questions to determine if you are a qualified investor. FINRA (Financial Industry Regulatory Authority) has rules that would prohibit a “restricted person” (individual associated with the financial services industry) from purchasing shares of a new issue. More information about FINRA Rule 5130 which places restrictions on the purchase and sale of Initial Equity Public Offerings can be found at http://finra.complinet.com/en/display/display_main.html?rbid=2403&element_id=4894&print=1. The broker where you invest will also have certain requirements to participate in an IPO as well. Typical requirement include minimum account balances which could be $250,000-$500,000. Another way to qualify could be based on trading volume. Most if not all companies will also have a flipping policy in place. Flipping is a term which means to sale shares bought in an IPO within a certain amount of time after purchase on the open market. If you are caught engaging in flipping it could exclude you from participating in future offerings.
Should you buy an IPO?
That’s not a simple question at all. Investing involves risk, and a company with no previous investment track record to examine is a huge one. As an investor you really have to look at the fundamentals that the company is based on and see why you want to hold that investment. On one hand the company could be wildly successful and the appreciation in share price could be significant if held for the long term. A prime example of a stock appreciating is GOOGLE, who this year marked its tenth year since its IPO by being up over 1,000%. On the contrary to success after IPO you have companies like Groupon, down over 60% in price after its IPO. An investor can always wait until after the IPO to purchase shares in the market, but this has risks also since the underwriters can support the trading of new issues in the first few days of trading. Once a company begins officially trading on one of the stock exchanges (New York Stock Exchange or NASDAQ) there is no telling how high or low the stock will be from the offering price (price at which you were allowed to get shares of the IPO).