What Does IPO Mean?

An initial public offering (IPO) is a company’s 1st entry into the public stock market. Sometimes referred to as “going public,” a company’s IPO allows it to raise capital by offering private shares of stock to investors on a public stock exchange.

Investing in an IPO has the potential to provide you with attractive returns. However, IPO investing doesn’t follow the exact same process as investing in an already-established company — so it’s important to do your research before you dive in. Our guide to IPO investing and the process a company needs to go through before going public will help you invest in upcoming IPOs more effectively. 

Why Do Companies Choose to Go Public with an IPO?

Going public through an Initial Public Offering (IPO) is a key decision for companies. This process changes private firms into publicly traded ones. It offers several advantages, such as improved operations and market presence. Companies often go public to raise capital for expansion, research, and reducing debt. An IPO can enhance a company's profile and increase brand recognition. It may also attract top talent and provide liquidity for shareholders. Venture capitalists and early investors often find this option appealing. However, companies need to consider market conditions and regulatory requirements. Understanding why companies choose to go public is important for grasping the effects of IPOs on businesses, investors, and the economy.

Strengthened Capacity for Raising Capital

When you buy shares of a company’s stock, you provide the company with capital it can use to fund new projects without the risk, restrictions and debt that come with seeking venture capital. This allows companies to raise a large amount of money very quickly.

Improved Advertising Abilities

In addition to raising more money for enhanced advertising opportunities, IPOs can also attract public attention. Publicly traded companies also tend to have more success in attracting talented management professionals and top-tier personnel with stock options.

Building Greater Trust with Investors

To qualify for an IPO, a company must undergo regular audits and submit security and income documentation to regulatory bodies like the U.S. Securities Exchange Commission (SEC). This can increase public trust among investors by providing a more transparent look into a company’s finances.

Considerations Before Companies Go Public with an IPO

Going public through an Initial Public Offering (IPO) is a significant step for any company. It changes ownership from private to public. This shift can provide more capital for growth and increase market visibility. However, companies need to think carefully before proceeding. They should evaluate their financial systems and regulatory needs. Market conditions also play a crucial role in the IPO's success. Companies should consider possible changes in management and stakeholder expectations. Being aware of these factors helps organizations make informed decisions and prepare for the challenges and benefits of being public.

Significant Upfront Expenses

Qualifying for an IPO is not an easy or inexpensive task. Before a company can go public, it needs to submit a wide array of paperwork and documentation that requires a team of lawyers, investment bankers, consultants and more to create. A poorly timed IPO can eat up a significant chunk of change that could have otherwise been put toward projects aimed at growth.

Heightened Financial Reporting Requirements

Even after a company launches its IPO, it must submit regular financial data to regulatory bodies, which then becomes public information. Public reporting holds executives to higher standards and allows shareholders to quickly access an intimate picture of a corporation’s financial health. In some cases, this may lead to a shareholder lawsuit if a company was mismanaged.

How an IPO Works

Investing in an IPO is a relatively simple process. If you’ve invested in stocks or mutual funds before, you’re probably already familiar with the process of placing an order through your broker to purchase shares of stock. However, the IPO investing process does vary a bit when compared to purchasing stock that’s already had its initial offering.

First, you’ll want to research upcoming IPOs. When a company meets all the criteria to go public, it will announce a date for its IPO, as well as an offering price. You can view a list of upcoming IPOs on the NASDAQ and the New York Stock Exchange here. Set an alarm for the date of the IPO that you’d like to buy, as you can begin investing at the specified IPO announcement date.

The offering price isn’t necessarily the amount of money you’ll pay to purchase a share of the company’s stock. Offering prices are limited to a fixed number of investors, including the company’s employees. These investors’ orders are filled before the opening bell rings, which means that the market price of each share can rise dramatically before you get a chance to place an order. For example, when retail investors were able to access Snapchat’s stock during its IPO, prices had already risen over 40% above the company’s offering price. Know how your IPO’s pricing is changing throughout the day to avoid accidentally overspending.

After you know what you want to purchase, you’ll need to open a brokerage account that supports IPO investing. You’ll typically be able to use your current brokerage account if you have one. However, due to high demand, some brokers may limit who is allowed to participate in upcoming IPOs. 

If you don’t have a brokerage account, we’ve included a list of our favorite brokers supporting IPOs below. Here’s a brief guide to investing in stocks if you’ve never bought or sold a share before — you’ll want to brush up on the basics well before the date of the IPO you’re interested in arrives.

On the date of the IPO, you can invest as soon as the stock goes public through your broker. Be sure that your account is funded and cleared before the opening bell. After you place an order and your order is filled, congratulations! You’re now among the first partial owners of a newly-launched public company.

Why Are IPOs Crucial for Traders and Investors?

IPOs, or Initial Public Offerings, mark a significant change for companies moving from private to public. They offer chances for traders and investors alike. This process allows companies to raise capital for growth and innovation. For investors, IPOs can be a way to invest in promising companies before prices increase. Traders can take advantage of the volatility and excitement that come with an IPO launch. Understanding IPOs is important for forming effective trading strategies and investment choices. In the next sections, we will look at why IPOs are important in trading and investing. We will discuss the opportunities they offer and the risks they pose.

Access to New Investment Opportunities

Initial Public Offerings (IPOs) offer traders and investors a chance to access promising companies early. Investing in IPO shares allows participants to benefit from growth potential before the shares are widely available. For many investors, particularly retail ones, IPO opportunities are limited. This early access can result in significant returns if the company does well after going public. The excitement around an IPO can also attract media attention. This increased interest often draws more investors, which raises demand for the shares.

Market Sentiment and Valuation Insights

IPOs serve as a barometer for market sentiment, reflecting investor confidence in the economy and specific sectors. The pricing and demand for newly issued shares offer valuable insights into current valuations and market trends, enabling investors to make informed decisions. For example, if a highly anticipated IPO experiences a strong debut, it may indicate robust investor interest and confidence in that sector, prompting other investors to explore similar opportunities. Conversely, a weak IPO performance could signal potential market corrections or a lack of interest in that industry, helping investors adjust their strategies accordingly.

Diversification of Investment Portfolios

IPOs enable investors to diversify their portfolios. This diversification helps reduce risk and improve overall returns. Newly public companies often operate within emerging markets or innovative fields. These areas may complement current investments. By including IPOs, investors limit their exposure to one market segment. They also have the chance to access high-growth sectors not present within their portfolios. Additionally, investing across various IPOs can protect against market volatility. Different industries react uniquely to economic changes.

IPO Process

Launching an IPO isn’t a simple process for any company. Companies must go through a series of financial auditing and underwriting processes before they may sell shares to public investors. These standards are regulated by the SEC under the Securities Act of 1933.  

The IPO process typically consists of 5 steps:

Step 1: Banking Selection

A corporation must first partner with a licensed investment bank to assist in launching its IPO and completing regulatory checks. Companies select a bank based on its fees, reputation, history of launching successful IPOs and more. Banks put together groups of buyers and create a plan to ensure that shares are sold at a select price in exchange for a commission.

Step 2: Due Diligence

After the company chooses an investment bank, the bank will draft a series of underwriting documents detailing the company’s history and plan for its initial offering. The bank then submits these documents to SEC officials.

Step 3: Pricing

Once the documents are approved by the SEC, the company and the bank work together to choose an offering price. Many IPOs are intentionally underpriced to attract buyers when the date of the IPO arrives.

Step 4: Stabilization

Once the IPO launches, the underwriting bank ensures that all shares of stock laid out in the due diligence documents are sold. If the bank cannot secure sufficient buyers, it may purchase shares itself.

Step 5: Transition to Market Competition

Once all shares of stock are spoken for, the volatility of the stock begins to cool as it enters the market competition stage. Six months after the IPO, inside investors are free to sell their shares as they please.

Where to Invest in an IPO

Are you ready to start investing in IPOs? The 1st step is to open a brokerage account. If you don’t already have an account, consider a few of our favorite brokers below that offer access to IPO investing. 

Getting in Early with IPOs

Though IPOs can be rewarding for investors, it’s important to remember that just because a company makes it to the IPO stage doesn’t guarantee success. With a lack of trading and financial history, it can be difficult to predict how a company will do in the future. Share prices also have a tendency to spike on the date of the IPO when excitement is high. If you plan to invest in an IPO, make sure you do as much research as possible before the big day arrives. 

Frequently Asked Questions