What To Know About An IPO


by Alexandra Pauline – July 5th, 2012

Investing in Hot New Companies!  

Even if you don’t know the first thing about the stock market, chances are you got a bit more curious after Facebook’s recent IPO.  But do you really have any idea what an IPO is?  Better brush up now – someday it just might be YOUR company that’s “going public!”

So, What Is An IPO?

The term IPO stands for “Initial Public Offering.”  So, what exactly are they “offering?”  They are offering (aka selling) equity (aka stock) in their company to the public for the first time (that’s where the “initial” comes in).  Prior to a public offering, a company is “privately held.”  So, after an IPO a private company becomes a public company.  There are a lot of cooks in the kitchen when it comes to taking a company public, some have strange names like…

The Underwriters

The term “underwriter” or “syndicate” always sounds a little sinister to me!  And if you followed the recent Facebook IPO drama, their lead underwriter, Morgan Stanley, was certainly portrayed as a villian in the press.  But what is this crucial role, exactly?

An underwriter is just an investment bank (or group of investment banks, led by a Lead Underwriter) reponsible for helping take a company public.  One of their biggest jobs?  To help properly price the IPO!  They work with the company to figure out exactly what price a share of stock will be set at on the first day of trading.

Is The Price Right?

A lot of the drama surrounding the recent Facebook IPO involved their lead underwriter and accusations that the initial offering share price was too high – thus overvaluing the stock.  The thing is, pricing an IPO is both an art and a science – you have to take into account both concrete facts (actual earnings) and the future potential of the company, including intangibles like future product development and innovation.

Investment banks make money off what is called an “underwriting spread” – they get big bucks for knowing how to successfully (well, hopefully) price and manage an IPO.  The easiest way to explain this spread is just like a mark-up on any sale – if Big Bank
buys a share of Hot Company for $1 and sells it to you for $2 – they make a profit of $1.

IPO Dough

So why would a company want to go public anyway?  To raise money!  In return for the cash infusion, shares are issued to the public which then are publicly traded. The investors’ hope is that the price of the stock will rise above the price they purchased it at – but don’t expect to turn a fast profit!  No matter how frenzied an IPO is, you’ve got to keep your wits about you!

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One Response to “What To Know About An IPO”

  1. louie says:

    Most investment advisors steer their clients away from purchasing an intial IPO, as they are aware of the spread on the day of the initial offering and want to wait to see where the stock settles, before making the purchase. Of course this is also an art and gamble, but a much more prudent one.

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