IPOs – What are they and how do you invest in them?
Let’s talk about IPOs. If you’ve found this article, you’re probably an astute investor looking to expand your investment profile and begin to diversify your financial portfolio. Deciding to invest in IPOs is one way to do just that. Now, it would be disingenuous to tell you that investing in IPOs is a simple, hassle-free process. It is not easy to access those early, low-cost IPO deals without being a big-money institutional investor. However, armed with knowledge, there are ways that you can enter the fray and still emerge victoriously.
What are IPOs?
So, what are IPOs? IPO is shorthand for initial public offering, which is quite simply the first time a private company offers its stock for sale on the general market. Generally, companies will exhaust avenues to raise capital privately before deciding to trade on the open market. For the organization looking for access to a much larger investors pool, the free-market exchange is the next logical step.
What then happens typically is the private company strikes a deal with one or more financial institutions who act as underwriters for the organization or company in this process. For a cut of the proceeds, underwriters shoulder some risks and help mitigate the company’s transition to the public market. They manage the sale of shares, always seeking to balance cost and demand skilfully. The good news for you is that IPO stock can be very cost-attractive compared to when a company’s public stock goes up for general sale.
How does it work?
It’s helpful to know how IPOs work; it’s also essential to understand the business jargon. The two major players in the IPO process are called the ‘issuer’ and the ‘syndicate.’ The private company who wishes to sell shares publicly is the ‘issuer,’ and the ‘syndicate’ refers to the team of underwriters who back and represent the company in its IPO venture.
‘Bookrunner’ is the term used for the leading bank in the syndicate. The cut that the underwriters attain as a result of services provided is called the ‘underwriting spread.’ The company and its underwriters draw up contracts, and together they determine the kind of agreement that’d offer the best deal for all parties concerned. The cost of the IPO itself is heavily dependent on the nature of the contract.
Contract types include best-efforts contracts, firm commitment contracts, and all-or-none contracts. Each of these dictates how shares can be priced and sold. It is the job of the underwriters’ to get the stock to go from place to place. So they will typically buy many of the first shares themselves and offer them to investors in their pool at rock bottom prices and then turn over their stock at a profit once public interest in the stock has driven up the price. If you can purchase good stock at IPO price, the risk can lead to a big reward.
How do you invest in them?
To invest in an IPO, you first need to be registered with a brokerage firm. Companies that are about to issue IPOs contact brokerage firms who then alert investors in their network. It’s not easy to get in on IPOs as a small-time investor, and many brokers will set qualifying standards for investors to have access to IPO stock. Once you qualify and have decided to invest in IPOs, you should be diligent about doing your research before taking the risk to buy IPO stock. The experts at money management suggest that you “Look at the last few years of the company’s revenue to see if it’s been growing. If you can find information about its debt, (if) it’s manageable, that is a plus.” It is also important to look at the underwriters. If a company has little-known underwriters, it could be a foreboding sign.
Above all, be careful. IPOs are risky business but making the right move at the right time can prove extremely profitable. Good luck!