Initial public offering (IPO) is a term that comes up a lot in investing. In a nutshell, it’s a process that a company goes through to become ‘listed’ on an exchange so investors—like you!—can buy and sell its shares.
In this blog post, we’re going to break down why a company might offer an IPO, how they do it, and what to do before you take part!
Why companies IPO
A company might offer an IPO so it can raise money to invest in future growth. Besides raising money, an IPO can benefit people who hold shares in the company before it lists, like employees, the founders, and other shareholders.
How a company lists
Before a company lists on an exchange—like the New Zealand Stock Exchange (NZX)—it’s considered private. A company might make the decision to ‘go public’ when it’s reached a certain value and it’s ready for the rigorous listing process.
First, the legal prep work
An investment bank often acts as the ‘underwriter’ to help a company go through the legal steps required to list. They’re responsible for preparing the legal documents, finding investors to buy the initial shares, and lots of other things!
All of this prep work—and the rules and legal requirements—aim to protect shareholders and investors.
Meeting the listing rules
An exchange sets the rules a private company needs to follow so it can list.
Most exchanges have similar rules, but there can be differences around things like a company’s minimum value and how trading happens.
In New Zealand, the NZX provides rules and guidelines for companies that want to publicly list.
Deciding on a share price
A company needs to do lots of research and analysis to figure out how much to sell their shares for.
If they sell their shares for too little, they might not raise as much money as they could have. But if they set the price too high, there might not be enough people who want to buy their shares!
Once they’ve decided on a price—and done all the necessary prep work, they can set a date for the IPO.
When shares start trading
Once a company lists, its shares can be bought or sold just like any other investment.
When trading starts, you might benefit from a rise in the share price—but this doesn’t always happen! Prices might go down depending on what the demand for the shares is like.
If the company performs badly (or the market’s trending down), your investment could lose value. If it fails or goes out of business, you could lose your entire investment.
If you want more control over how much you buy or sell your shares for, you can place a limit order.
Demand for shares could be high—or low
An IPO can be ‘oversubscribed’. This means people want to buy more shares than a company is offering. If this happens, the offer might be ‘scaled’, which means investors may end up getting fewer shares than the amount they’d like to buy.
IPOs can be ‘undersubscribed’ too, which means the company has offered more shares than people want to buy. If an IPO is undersubscribed, it’s worth looking at why the demand is low.
The share price could drop
IPOs can be exciting, but it can be risky for a company—and new shareholders too.
Facebook (FB) went public in May 2012 at a price of US$38 per share. By September 2012, it had dropped below US$18 per share. Ouch. It took over a year to reach the IPO price again.
Investors need to be kept in the loop
A listed company needs to stick to the listing rules and legal requirements. It must also continually provide investors with enough information to make informed choices.
Listed companies need to be regularly audited by a professional auditor, have a board, and release reports about how the business is performing.
All of this stuff is expensive, so listed companies tend to be larger, or have plans to grow in the future.
Taking part in an IPO
An IPO gives you the opportunity to invest in a company’s shares while they’re on the ‘primary market’. The primary market is where shares are issued for the first time. The shares go into the ‘secondary market’ when they’re listed and traded on a stock exchange.
Most investors don’t have access to the primary market—it’s usually limited to ‘wholesale investors’. According to the Financial Markets Conduct Act 2013, they’re usually investors with a lot of experience with financial products or a lot of money to invest—or both!
It’s all right to feel a little out of your depth. But there are a few things you can do to help manage your feelings of uncertainty.
Do your due diligence
Due diligence is just another way of saying ‘doing your homework’.
A company will release a document called a product disclosure statement (PDS) before they list—make sure you read it! It tells you key info about the company, like their financial position and performance. You can also find out why the company is making the offer, how they expect your investment to make a return, as well as any risks to the business that might affect your investment.
Consider risk
While IPOs give you the opportunity to invest in a company before it lists, as with any investment, there are also associated risks. You should consider your risk appetite, and look at how these shares might fit within your wider investment strategy and portfolio.
Ok, now for the legal bit
Investing involves risk. You aren’t guaranteed to make money, and you might lose the money you start with. We don’t provide personalised advice or recommendations. Any information we provide is general only and current at the time written.