This article explains in-depth how initial public offerings (IPOs) work and how to gain exposure to private companies that are floating their shares on the stock market.
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An initial public offering describes the process of how a privately held company sells its shares on their chosen stock market, usually as part of a new stock issuance. This can be a fairly long procedure and it involves selecting underwriters, raising funding and marketing the process in order to raise investor attention.
When a company is registering for an IPO, it must meet the following criteria:
The figures for the above criteria are not set in stone and therefore listing requirements fluctuate between each individual stock exchange. The appeal for companies to go public is usually boosted by positive market conditions and supportive monetary policies.
When the IPO has passed, traders can then decide whether to take a buy or sell position based on whether they think its share price will rise or fall. On our Next Generation trading platform, users can speculate on the underlying price movements of newly listed stocks using spread bets and CFDs. Learn more about derivative trading.
A company that is planning an IPO will first select an investment bank that will act as the underwriter of the IPO. The investment bank should fulfil the following criteria: reputation, industry expertise and quality of research. The underwriter acts almost as a broker between the private company and the public to help with selling its initial issue of shares. The underwriter is also responsible for stabilizing the market after the stock has been issued. If there is an imbalance of orders on the initial day of trading, it will then purchase shares of the company at the offering price or below it to reduce the likelihood of the stock plummeting.
The company must then choose a stock exchange on which to debut their newly public shares. This usually coincides with the country and industry that the company operates in. For example, the NASDAQ exchange is favoured by the majority of technology companies in the US, whereas the New York Stock Exchange is home to many long-standing blue-chip stocks.
Following approval from the SEC, an offer price and effective date are set by the investment bank. This price is usually based on company fundamentals such as their financial performance and what is believed to be the intrinsic value of the company. It should also be priced reasonably to attract a substantial amount of investor attention. When the company goes public, the private shareholders’ shares will be valued at the same price as the public shares. This is usually at a higher value than before the IPO, so they could potentially profit from the relative returns by selling when the lock-up period ends.
A number of trading platforms specialise in pre- and upcoming IPOs, where you can browse and choose a stock to invest in before its future IPO is carried out. Once the company is public, however, you can trade it like any other share in the stock market, using financial derivatives such as futures, forwards and options contracts.
After the company has gone live on the stock market, there is typically a period of 90-180 days where investors cannot sell their shares, which is referred to as the ‘lock-up period’. This usually applies to insiders such as the company’s founders and employees but can also include early investors. The point of a lock-up period is to prevent the stock price from falling if the market is overwhelmed with a large number of shares sold by insiders.
Companies have the ability to raise even more capital in the future. A secondary offering after the IPO releases the sale of new stock to the public in order to raise more funds for operations. This, in turn, dilutes the percentage of individual ownership for the original investors, which can cause negative investor sentiment.
An upcoming IPO’s share price is speculated on before it is actually announced, in relation to its overall revenue and income. However, an IPO can be under-priced if its sponsors cannot accurately predict the demand for the company’s shares.
Another theory is that some companies under-price their IPO below market value in order to attract a wider number of investors. A company that rises by a large amount on its IPO day may get a substantial amount of publicity, in turn further stimulating demand.
It is also speculated that IPOs are under-priced by their underwriters, who are typically large investment banks, in order to give their clients who are buying the stock a good deal and near immediate gains when the IPO goes live. This way, it ensures that the underwriter’s clients will be happy and investors will buy up all the shares of the company’s IPO, rather than having some shares left over.
The IPO market has been rising in recent years, with 209 IPOs listed in 2020 alone. However, there has also been a rise of direct listings and SPAC mergers, where the latter accounted for an even higher figure of 248. Therefore, an increasing number of businesses are choosing to use a special-purpose acquisition company (SPAC) as it tends to offer a slightly cheaper and quicker process than a traditional IPO. Some of the largest stock market debuts in recent years were direct listings or SPAC mergers, such as Coinbase, Virgin Galactic and Palantir Technologies.
See our list of newly-created SPACs and SPAC mergers that have been announced >
Our hubpage for upcoming IPOs and new stocks covers a number of companies that are currently involved in the IPO process. See which shares have recently gone public on the stock market and are available to trade using spread bets and CFDs on our Next Generation trading platform.
You can also keep up to date with the latest news and analysis for the stock market, as we keep our online platform updated with daily reports and predictions from our professional market analysts. Alternatively, if you would like to see data from external news providers, our news and insights section offers free fundamental analysis stock reports from Morningstar and live updates on the share market from Reuters.
Interested in receiving notifications about IPO news? With our trading alerts feature, you can choose to receive breaking news alerts on your desktop device or mobile app, through either push notifications, email or SMS.
Before the IPO occurs, there is sometimes a private sale of a company’s shares before the stock is listed on the chosen exchange. These buyers are usually venture capitalists, as mentioned above, as well as private equity investors, hedge funds and other private investors that aim to profit from a stake in the company in the future. They will also be given a discount from the upcoming IPO price to attract a larger number of investors.
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