PostHeaderIcon Investing in an Initial Public Offering (IPO)

The term initial public offering (IPO) was made popular during the boom in technology stock market in the late 1990s. During this time, there wasn’t a day when young dotcom entrepreneurs became millionaires with their website and they were living large with the proceeds from the IPOs of their internet companies. So how did they get rich so fast and what really is IPO?

An IPO or initial public offering is the first sale of stock by the company to inventors on a public stock exchange. The main purpose of an IPO is the raise money money and capital for the corporation, by not issuing equity to the public. It would be the first public issuance of a said company’s shares.

Majority of IPOs can be found at Nasdaq stock exchange,  where computer and information technology-related companies are listed. These companies are also similarly listed at the Over The Counter Bulletin Board (OTCBB) exchange, namely those with much lower stock prices and more affordable than companies listed on a major stock exchange.

As soon as a company lists its shares on a public exchange, it will immediately issue new, additional shares to raise the capital. The company earns directly from newly-issued shares. Therefore an IPO allows the company to tap a wider pool of stock market investors, providing it with a large amount of capital for its future growth. Also, when a company is listed, there is a right issue wherein it can also issue advance shares to provide capital for expansion, without being subjected to debt.

So how can one get in on an IPO? To do this, one must understand how an IPO gets done through a process known as underwriting. When deciding to go public, the first thing a company does is to hire one or more investment banks that serve as "underwriters."  In some ways, underwriters function as the  middlemen between the companies and the investing public. Underwriters approach investors with the right allocation and pricing offers to sell its shares to the public. Common methods include Dutch auction, firm commitment, best efforts, a bought deal, and self distribution of stock.

The processing of an IPO mainly consists of putting together formal documents for the Securities and Exchange Commission and selling the issuances to clients belonging to institutions. To get shares in an IPO, one needs to have a frequently traded account with one of the investments banks as an underwriting syndicate. Underwriters keep a commission based on the percentage of the value of shares they have sold.

Through the years, IPOs both in the US and worldwide are said to be underpriced. Underpricing an IPO generates additional interest in the stock, when it was first publicly traded. This leads to significant gains to investors who have been offered allocation prices. Nevertheless, IPO underpricing leaves lost capital that could have been used for raising the company, with offers at a higher price.

Overpricing IPOs is also an important consideration. Stocks offered at a higher price than what the market could possibly pay may cause difficulty for underwriters in selling the shares. The stocks lose more of its value if it fails on the initial day of trading, therefore worsening its marketability.

As such, many factors should be considered by investment banks when pricing IPOs. Stocks should be high enough to raise sufficient capital for the company, and also low enough  to generate market interest.


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