Initial Public Offering (IPO) Definition

An initial public offering (IPO), also known as a flotation, is a company’s first release of buyable stocks or bonds to the market. IPOs are frequently issued by smaller companies looking to expand with the capital selling equity would bring. However, it is also common for governments to oversee IPOs by offering services owned by the state to the public. A recent pertinent example was the flotation of Royal Mail shares by the UK government.

When a company’s stocks are sold to the public, this usually marks the transition from a privately owned entity, with few shareholders, to a public one, which may have many thousands of people holding its shares. For this reason, undergoing an IPO is also commonly referred to as ‘going public’.

How Are Shares Floated?

An IPO can only occur with the help of the services of an underwriter, who can help determine the type of stocks to be issued (whether common or preferred), how much to offer it for, and the opportune moment for bringing them to market. Underwriters form an important part of investment banks, and can also help business owners adapt to the new waves of regulations they will be subject to upon going public. Public companies require a board of directors who must report financial performance every quarter and must work to ensure the company is run in the shareholders’ best interests, making maximal return on their investments in the firm.

Why Perform An IPO?

With the additional regulatory requirements placed upon the management of a company on going public, it is only natural to wonder what makes the whole process worth it. The answer is simple: money, and lots of it. Selling shares will often provide instantly usable capital to invest in new processes, staff, expansion, and services. If a firm’s management is astute, this can lead to an increase in working profits. There are other benefits beyond the immediately obvious. Having the increased level of scrutiny placed upon working processes due to the transparency requirements enforced on public companies can make debt easier to obtain, and often cheaper. Public companies can also offer additional incentives to employees such as preferred stocks and other ownership plans. This can make it easier to attract and retain top industry talent.

Investors and IPOs

Budding investors will often keep their eyes peeled for up and coming IPOs. This is because sometimes firms are undervalued by their underwriters, resulting in opportunities for big profits for the wily. The aforementioned Royal Mail IPO was one such example. Some analysts estimated it had been underestimated by up to £6bn! The shares, which were initially valued at 330p, rapidly jumped to a high of 618p, before settling around 500p.

However, the publicity which surrounded the ludicrous profits being made on the Mail has seen more recent IPOs erring on the side of overvaluation, leading to a lack of investor interest. It is always worth conducting thorough research into any company before buying into it. This is particularly so for IPOs. Not only is financial information likely to have previously been kept from prying public eyes, but many IPOs also have clauses where buyers are forbidden to sell within a period after flotation. If you’re planning to invest in a company going public, it’s worth taking great care to ensure you have made the right decision!

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