IPO: The ultimate trader’s guide to initial public offerings
An initial public offering or IPO can be an exciting trading opportunity. It’s the first chance that most investors and traders get to grab a slice of some of the hottest new companies.
But what is an IPO, and how does it work?
In this article:
- IPO meaning
- How does an IPO work?
- IPO versus direct listing
- Can I trade IPOs?
What is an IPO?
An IPO, also known as a flotation, is where a private company sells new shares to public investors. It’s a way of raising capital to fund further growth and innovation, and also allows existing investors to reap the rewards of backing the company during its start-up phase.
Up until this point, the company is privately owned by the people founded it, and any staff or early investors who were given shares.
How does an initial public offering work?
A company that wishes to go public will need to meet certain criteria laid out by the domestic market regulator – such as the Securities and Exchange Commission (SEC) in the United States. Companies can also choose what exchange they want to list on, such as the New York Stock Exchange or the NASDAQ, and these too have their own requirements.
Companies need the help of an underwriter or underwriters to hold an IPO. These are investment banks such as Goldman Sachs, Morgan Stanley, and JPMorgan, and are responsible for arranging and marketing the initial public offering.
It’s common for underwriters to assume all the risk of the IPO by buying all of the new shares being issued by the company, and then selling the stock to public investors.
IPOs: Roadshows and pricing
In the run-up to an IPO, a company will issue a prospectus and hold investor roadshows across the country in which it is listing in order to drum up interest in the flotation. The prospectus will give a target price range for the shares to be issued. This is often adjusted to reflect market demand as the company’s stock debut draws near.
Sometimes the stock of the company is so in demand ahead of its initial public offering that the company decides to issue more shares than originally planned – usually the underwriters are given the power to automatically increase the size of the issuance by a set amount of shares if demand warrants it.
Check out the upcoming 2020 IPOs to stay on top of the roadshows and pricing data of this year’s most anticipated public offerings.
What happens if demand is higher or lower than expected?
Although the underwriter buys the new shares at the final initial offer price, the stock can open above or below this price on its first day of trading. If the company going public and the underwriters have overestimated demand for the stock, the underwriter may have to sell the shares for a lower price than it bought them.
And if demand has been underestimated, the underwriter may be able to sell the stock for a much higher price than it bought them. Doing so is likely to damage their reputation, however, so underwriters have an incentive to try and sell the shares for as close to the initial offer price as possible.
What’s the difference between an IPO and a direct listing?
Companies who don’t want to hold an initial public offering may instead opt for a direct listing. With an IPO, the company going public is selling new shares, giving away control of more of the business.
A direct listing, on the other hand, is where a company allows its existing shareholders to sell the stock on public markets. This allows early investors to reap the benefits of backing the company, and allows the company to trade publicly without giving away control through the issuing of new shares.
A company does not need to hire underwriters in order to hold a direct listing – saving it a lot of money in fees. This also means existing investors may be able to sell their stock for a higher price.
Can I trade IPOs?
IPOs can represent some of the biggest trading opportunities on the stock market. Companies such as Beyond Meat have seen their stock surge since they went public, while others, like Uber and Lyft, have performed poorly.
With Marketsx you can trade companies before they go public with our exclusive grey markets, or trade CFDs on the hottest companies on the day they debut, as well as taking positions on ETFs that track the newest stocks on the market.