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Initial Public Offering (IPO)

Important information - We do not offer advice on the suitability of any IPOs or bond launches for you. Like any investment, there are risks and it is vital that you have all the information you need to make an informed decision. Any decision to invest in an IPO, share offer or bond launch should be made solely on the basis of the information contained in the Prospectus, and any supplement thereto. If you have any doubts about its suitability, please seek expert advice. The value of all investments can fall as well as rise, so you may get back less than you invested.

What is an Initial Public offering (IPO)?

An initial public offering (IPO) is when a company lists its shares on the stock market for the first time. It’s sometimes called ‘going public’.

It gives investors the chance to buy shares before they become tradable on the secondary market – where investors meet to buy and sell shares in publicly-listed companies.

How does an Initial Public Offering (IPO) work?

Before a company IPOs and goes public, it’s considered a private company. The process for becoming a publicly traded company includes:

  1. The intention to float - the company announces to the stock market they want to float the company on the stock market through an IPO.
  2. Release of prospectus, any supplementary information and financial documents - the company then releases a prospectus. This aims to be the official document relating to the launch and will describe the terms of the IPO in detail. The directors have to give a full and fair description of the business, including the risks, in the prospectus.
  3. Sales of shares - applications for the shares begin. The IPO will be open for a fixed time known as the offer Period.
  4. Offer period closes - applications will be finalised and investors allocated the shares based on the size of their application and any necessary scaling.
  5. Shares admitted to the stock market - also known as the secondary market. The shares can be bought or sold during normal market hours. Once on the secondary market, the price of the shares can rise and fall.

It’s important for investors to note that IPOs can get pulled for a number of reasons, such as lack of investor interest or mis-priced shares.

Underwriters in the Initial Public Offering (IPO) process

When a company’s ready to go public, they’ll need an underwriter – typically an investment bank. Sometimes, a group of banks will come together to form a syndicate. That means they can pool their resources to underwrite an IPO that would be too big for one bank to handle alone. The underwriter helps set the IPO price by shopping the shares around to big clients like funds and investment banks. They gauge interest in the IPO and price the shares accordingly. Once they have an idea of who’s buying, the underwriter will guarantee the number of shares to be sold at the set price. If any shares are leftover, the underwriter buys the surplus.

How is an Initial Public Offering (IPO) priced?

IPO pricing can be different depending on the IPO in question but one approach (which roughly mirrors the general approach most underwriters take) is what’s called a Dutch auction. In this scenario, investors submit bids for the number of shares they’ll buy and the highest price they’ll pay. The shares are awarded to the highest bidders, but all bidders pay the same price (the highest price which results in the sale of all shares). Here’s an example:

Imagine 500 shares are up for grabs:

Investor A bids £10 per share for 100 shares
Investor B bids £9 per share for 200 shares
Investor C bids £8 per share for 200 shares
Investor D bids £7 per share for 100 shares

Investors A, B and C have bid for the 500 shares at a higher price than investor D. Therefore, the underwriter will sell all the shares on offer to investors A, B and C at £8 - the highest price at which the underwriter can sell all the shares on offer. Investor D will be completely left out.

Learn more about how IPOs and new issues work

Why do companies do an IPO?

At a certain point, private companies might decide to ‘go public’ to raise more cash. This could be because founders and early investors in a private company need to fund new growth in the business, or to cash in some of their investment. That’s why they’ve decided to give up some of their ownership by offering shares in an IPO.

Once a company has gone public, fundraising is much easier because it now has a mainline to investors on the market and has more opportunity to grow. Publicly traded companies can raise money by issuing shares in a secondary offering down the line.

If a company is selling new shares to pay off debt or so existing investors can exit the business, investors should be cautious. You’re buying a business which could be in trouble or that others don’t want to own. But other motivations like funding strategic acquisitions or investing in new technology are much more promising goals.

Advantages and disadvantages of an IPO

  • Fundraising – money raised from an IPO can benefit a growing company in several ways. This could include financing research and development, hiring employees, building, reducing debt, funding capital expenditure, acquiring new technology or other companies, or any number of other possibilities.
  • Opportunity to exit - every company will have different people who’ve contributed large amounts of time, money and resource in the hope of creating a successful company. It could be years before they receive anything back from their contributions. An IPO is an opportunity for these stakeholders to receive some money back or sell off what they have tied up in the company.
  • Higher risk for investors - investing in IPOs and individual companies isn’t right for everyone. It’s a higher-risk way to invest your money. When a company first lists on the stock market its share price can rise and fall quickly. The value of your investment depends on the fate of that company. If it fails, you risk losing your whole investment.

How should investors evaluate an IPO?

When you invest in an IPO, reading the prospectus and evaluating the company’s financial health is your first step. It’s the most useful tool in deciding whether or not to invest.

It can be difficult working out what a new company is worth without any historical share price data to look at. That makes comparing with listed competitors a crucial tool.

Let’s say Company A and Company B are in the same industry. Company B is looking to list its shares on the stock exchange so comparing something like the price-to-earnings (P/E) ratio of company A is a good starting point for valuation.

However, lots of young companies don’t turn a profit so widely used valuation metrics, like price-to-earnings, don’t apply. In that case, a good place to start is the price-to-sales ratio (P/S).

Again, compare it against the P/S ratio of similar businesses within the same industry. If the IPO stock has a particular advantage, like size or new technology, its sales might be worth more than those of competitors. One way to gauge this is to look at forecast sales, which should also appear in the prospectus. Ratios/figures shouldn’t be looked at in isolation. If you’re at all unsure you should seek advice.

IPOs usually give investors a price range at which the shares will debut. When you commit to buying you won’t know the exact share price, just that it will be within that range.

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