Initial Public Offering

What is an Initial Public Offering (IPO)?


An IPO, or initial public offering, refers to the initial sale of a companies stock to the public.  IPO's are utilized primarily by small-cap companies who are looking to expand their operations; however, some larger private companies may take this route as well.  Goldman Sachs is a good example of this, issuing an IPO in 1999 after being a well established private company for over 100 years.  An IPO is a means of obtaining capital from investors in exchange for an ownership stake in the company.  Ideal candidates for an IPO are companies with solid, long term growth in sales and earnings and companies which have a relevant business concept which has strong growth potential going forward. 

These companies will have to be strong enough financially to meet the listing guidelines on the major stock exchanges; such as the AMEX, NASDAQ, or NYSE.  It is in these secondary markets where a companies shares will trade hands after the initial placement. 

Underwriting an IPO


An IPO is typically done through an underwriter who will act as the "sales" agent for the company.  The deal may be structured through the employment of a single firm, or multiple.  Typically, larger deals are underwritten by a syndicate.  This basically means that multiple investment banks will attempt to sell stock to investors with a lead underwriter taking responsibility for ensuring that all the shares are sold.  The underwriters will purchase the shares from the company at a discount and sell them through their sales channel at the IPO price, which is higher.  Before selling the shares to the public, the underwriters and the issuing company will decide on the terms of the agreement which stipulate how to divide the shares up between institutional investors and small investors.  Companies prefer a larger portion of the shares be allocated to institutional investors, as they are more prone to holding for the longer term rather than buying or selling for short term profits. 

For this reason, it is more difficult for individual investors to buy IPO's through their brokerage account; there just isn't a large amount issued to the general public.  This was an issue during the dot com IPO frenzy in the late 90's where demand far outweighed supply for these issues, but this phenomena has died out making it far easier for investors to get shares at a reasonable price.

As suggested earlier, an IPO is most successful in a time where investors are bullish on the prospects of the economy and overall stock prices are moving higher.  In this situation, investors are more prone to take risks and drive up prices

It should be noted that not all brokerage firms will offer every IPO to their clients.  Ultimately, each brokerage house has to make a judgement call on the risk associated to offering these newly issued shares to their client base.

There are substantial fees involved with filing an IPO; for example, there are costs associated to underwriting, lawyers, accountants, and other miscellaneous items that come up.  For this reason, if the company is not issuing a large amount of stock, the deal will not be worth their time.
Tim Ord
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