How Do IPOs Work?

IPO stands for Initial Public Offering. An IPO is a company’s first sale of stock to the public and occurs when a private company makes an offer to sell its securities to the investment community. It is usually conducted on the stock exchange by an investment bank underwriter, who is paid a commission for doing so. The first sale of stocks to the public is used as a way of raising cash to help the company operate more efficiently and grow at a faster rate.

How Do IPOs Work?

When a company decides to go public and sell shares of stock to the public, it hires an investment bank to help it. The investment bank will help the company set a price for the stock and then market it to potential investors. The company will also file paperwork with the Securities and Exchange Commission (SEC). This paperwork includes a prospectus, which is a document that provides information about the company and its stock. The SEC reviews the prospectus and makes sure that it complies with securities laws. Once it’s approved, the investment bank can start marketing the stock to potential investors. An IPO is one of many ways that companies can raise cash without borrowing from banks or investors. For example, a company can borrow money from a bank using its assets as collateral or it can pool together all of the company’s resources and sell them off in pieces. In cases when there’s not much revenue coming in within a specific time period, an IPO could be just what a company needs to keep going. Not only does an IPO provide immediate cash for a company, but it also opens up the door to new investors who are interested in the company’s long-term prospects. During an IPO, the company sells a portion of its equity (or ownership) to public investors. The investment bank underwriter usually buys most of the shares and then resells them to institutional and retail investors. The price at which a company initially sells its shares is called the offer price. It is typically set high in order to ensure that there is interest from buyers. The final price, however, is determined by how much demand there is for the stock once it goes on sale.

Who Can Buy IPO Stocks?

IPO shares are available to anyone who wishes to buy them. If an investor is interested in purchasing shares, he or she should contact the company directly. Typically though, the big institutional investors are the ones who get the first crack at buying shares during an IPO. This is because they have the financial resources to buy large blocks of stock. Small investors can also buy shares, but they may not get the same price as the institutional investors. In addition, there is a risk that the stock may not be available once it goes on sale.

How to Buy IPO Stocks

It is important for investors to thoroughly research a company before buying any type of stock. While many IPOs are solid investments, not all of them are true blue-chip stocks. When someone wants to buy into an IPO, they can simply pick up the phone and call the company or its investment bank underwriter. Alternatively, an individual can submit a share request form through his or her account representative at their discount brokerage firm. This request allows investors to take part in future IPOs by offering them first dibs on new issues. However, not all brokerages have access to IPO shares or some of them have limited access. If you get the chance to get into an IPO sale, the process is the same as with any other stock purchase. You simply have to fill out an order form and specify the number of shares you want to buy.

Advantages of Investing in IPOs

There are a number of reasons why investors may want to consider buying into an IPO.

First Opportunity to Purchase a New Issue

If you’re interested in purchasing a hot new stock that is likely to take off, then participating in an IPO may be right for you. You can buy the stock before it hits any other exchanges and potentially see massive returns on your original investment.

Accumulate Money Fast

When individuals invest in IPOs, they could accumulate enough capital within months or even weeks rather than years. This type of return is unheard of with traditional savings accounts and dividend-paying stocks.

Access to Institutional Investors

By pooling together all of their resources, it’s possible for small investors to gain access to the deep pockets of institutional investors. This can give you an edge when buying shares during an IPO because your orders are placed right alongside those of other large financial institutions instead of being pushed to the back of the line.

Disadvantages of Investing in IPOs

While there are several reasons why someone should consider investing in IPOs, there are also some potential disadvantages that one needs to be aware of before buying into a new stock offering.

First Chance to See If the Company Blew It

When you’re looking at buying shares for the first time, it’s important that you investigate how well a company is doing financially. Keep an eye out for signs that things aren’t going as planned, such as missed earnings targets or a slowdown in sales.

Huge Price Swings

Since IPOs are typically in high demand, stock prices tend to jump around a lot in the early days and weeks after they first hit the market. This can result in some pretty large losses or gains if an investor sells too soon or holds on for too long.

Lack of Liquidity

One issue that often arises with IPOs is a lack of liquidity. This means that it can be difficult to find someone who wants to buy your shares, especially if the stock has been dropping in value.

Tips in Investing in IPOs

Do Your Homework

The most important thing for any investor is to do their homework before investing their hard-earned money into anything. This is especially true if you’re considering purchasing shares in an IPO. Since this is a new offering, there’s no guarantee that the company behind it will be successful or profitable if things go sideways after their stock starts trading on the open market.

Review the Prospectus

If you are thinking of making an investment in an IPO, make sure to thoroughly review all of its paperwork, including any prospectus available. This document should provide details on how much money needs to be raised through the IPO and what type of investors will get priority when buying these stocks. Also, take into consideration where your broker stands on buying this new issue; some may not have access or be able to get as many shares as others. You’ll want to ensure that you have ample time to meet any deadlines so you don’t miss out on the opportunity.

Pick Companies With Strong Underwriters

When it comes to picking a company to invest in, try to focus on those with strong underwriters. An underwriter is the bank or investment firm that agrees to purchase all of the shares of an IPO if it doesn’t sell out. This increases the chances that your stock will be available at the time you want to purchase it and also bolsters the reputation of the company being offered.

Consider the Lock-Up Period

A lock-up period is the amount of time that an IPO’s underwriters will hold onto some or all of their shares before they can sell them. This is done to ensure that there is enough supply for interested investors while reducing any volatility in the stock price. It’s worth noting that this period typically lasts between 90 and 180 days, depending on how well the IPO does at first. If you want access to these shares sooner than that, then you might want to consider looking for another company whose offering doesn’t have a lock-up provision.

The Bottom Line

IPOs can be a great way for small investors to get in on the ground floor of some of the hottest new stocks. However, it’s important to remember that there is always some risk associated with investing in a new company. Do your homework before taking the plunge and sure you’re comfortable with the potential risks and returns.

Individual investors and institutional investors such as mutual funds and hedge funds can both take part in IPOs, although the latter typically purchases much larger quantities of newly issued shares than "regular" individual investors.
There are several reasons why companies might choose to go public, but the most common one is that they need the money. By issuing shares and becoming a publicly-traded company, firms can raise billions of dollars that they can then use to expand their businesses, make acquisitions, or simply pay down debt.
An underwriter is a bank or investment firm that agrees to purchase all of the shares of an IPO if it doesn't sell out. This increases the chances that your stock will be available at the time you want to purchase it and also bolsters the reputation of the company being offered.
This is largely a matter of preference since there are pros and cons associated with both. However, if you are looking for less risk in your investment, then it may be best to stick with well-established companies. Many new startups fail within the first few years after going public, which could end up costing you dearly if this happens to one of your holdings.
There are a few ways to do this. One is to look for companies that have been around for a while and have a good track record. Another is to use a financial tool to find firms with high-quality ratings from these organizations. Finally, you can also read analyst reports to see which investment banks are most bullish on a particular company.

True Tamplin, BSc, CEPF®

About the Author
True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, or check out his speaker profile on the CFA Institute website.