What is an IPO and how does it work?

What is an initial public offering (IPO)?

An initial public offering (IPO) is one of the methods that companies can use to go public – which will make its stock available to retail traders and investors. The company will decide how many shares it wants to offer, and an investment bank will suggest an initial price for the shares based on the predicted demand for them.

It should be noted that trading or investing in IPO shares can be riskier than getting exposure to established stocks, due to the unpredictability of the new listing.

Why do companies want to go public?

Companies want to go public for different reasons, depending on their circumstances. Most are looking to raise capital to fund expansion, pay debts, attract and retain talent, or monetise assets. A company may also want to list on a stock exchange to improve its public profile.

How does the IPO process work?

The IPO process starts when a company decides that it wants to sell its shares to the public via a stock exchange. First, an audit must be conducted, which considers all aspects of a company’s financials.

If everything is in order, the business then has to prepare a registration statement to file with the appropriate exchange commission, like the Securities and Exchange Commission (SEC) in the US or the Financial Conduct Authority (FCA) in the UK.

Next, the stock exchange that the company wants to list on will review the application, after which it’s either accepted – sometimes subject to certain amendments – or rejected. If it’s approved, the company will enlist the help of an underwriter to help it decide how many shares to issue and at which price.

The underwriter is usually a bank, and it’s their job to start a book building process, looking for investors to subscribe to (register their interest in) the IPO. Any interested parties will receive a prospectus of information about the shares, where they’ll be listed and the potential opening price.

The IPO will be the first chance for non-private investors to buy the company’s shares in what is known as the primary market – a transaction between the original holder (the company) and an investor.

There have been restrictions on IPOs that mean only institutional investors can participate fully in this primary market, while retail investors could only participate in the secondary market – when shares are exchanged between investors.

Who sets the IPO price?

Investment banks set the IPO price. The company decides how many of its shares it wants to sell to the public and then the nominated investment bank does a valuation of the business. Once that’s done, an initial share price is released, and the public can start trading shares when the listing happens.

*Note: Primary market IPO trading is not available with us