IPO - Initial Public Offering
An initial public offering (IPO) or stock market launch is a type of public offering where shares of stock in a company are sold to the general public, on a securities exchange, for the first time. Through this process, a private company transforms into a public company. Initial public offerings are used by companies to raise expansion capital, to possibly monetize the investments of early private investors, and to become publicly traded enterprises. A company selling shares is never required to repay the capital to its public investors. After the IPO, when shares trade freely in the open market, money passes between public investors. Although an IPO offers many advantages, there are also significant disadvantages, chief among these the costs associated with the process and the requirement to disclose certain information that could prove helpful to competitors, or create difficulties with vendors.
Details of the proposed offering are disclosed to potential purchasers in the form of a lengthy document known as a prospectus. Most companies undertake an IPO with the assistance of an investment banking firm acting in the capacity of an underwriter. Underwriters provide several services, including help with correctly assessing the value of shares (share price), and establishing a public market for shares (initial sale). Alternative methods such as the dutch auction have also been explored. In terms of size and public participation, the most notable example of this method is the Google IPO. China has recently emerged as a major IPO market, with several of the largest IPOs taking place in that country.
What to Do If a Broker Calls to Pitch an IPO
Selling shares of stock to the public through an initial public offering (IPO) is a tried and true way for a company to raise money by expanding its ownership base. Purchasing any securities product, including an IPO, carries risk. Before you invest,
- Be alert to warning signs that might signal a fraudulent sales pitch such as:
- Guarantees of big profits with little or no risk
- Claims that IPOs are always good investments
- Promises that your broker is not receiving any compensation
- Suggestions that you are getting inside (non-public) information
- Pressure tactics to invest immediately
- Request - and read - a preliminary prospectus. Also known as a "red herring," this document must be filed with the SEC. Pay particular attention to the risk factors section. Be wary if a broker tells you that you don’t need a copy of the prospectus to make a decision, or to ignore the prospectus or certain information in it.
- Ask and get answers to any and all questions you might have about the investment, specifically:
- Has the SEC declared the offering "effective," meaning that the company can complete its securities sales?
- Always remember: this only means that the company has disclosed certain facts. This is not a seal of approval from the SEC.
- Do you view the IPO as a short- or long-term investment?
- Exactly what does the company do?
- What is its operating history (profits, revenues, or history of losses) as a private entity?
- What are the major risks facing the company?
- Hang up if you feel you are not getting straight answers to your questions or are being pressured to act immediately or encouraged to invest an amount that is beyond your means.
- If you decide to invest, read the final prospectus, paying particular attention to the changes made from the preliminary prospectus.
- If you do decide to invest in an IPO, or are considering it, you should know:
- You should not send your money to your broker (or the broker’s clearing agent) prior to the effective date, since the securities can’t be sold prior to that date.
- Unless specifically stated in the prospectus, there is no minimum number or shares you must buy.
- You do not have to agree to buy shares in the company after it begins trading publicly in order to buy shares of the IPO.
- You have the right to request that your name be placed on a "do not call" list to avoid future phone calls.
Don’t forget: if an investment sounds too good to be true—it probably is. In my experience, most IPO's do not go up because unless the demand is truly great as they offer more and more shares to the public they deplete the buyers so that in order to sell all of the shares they are offering they must drop the price. Once the price begins to fall the initial investors see the price dropping and dump their shares which can drive the price down quickly. Remember companies go public to RAISE MONEY. Private companies that are doing well don't need to raise money and so they don't go public. Very popular companies may well increase in price during the initial offering however more often than not, this is not the case.
