An initial public offering (IPO), or ‘float’, is when a private company lists on a stock exchange to raise funds by selling shares to investors, including members of the public.
Companies use IPOs to raise money that can then be reinvested to help grow the business. IPOs give investors the chance to buy shares at a set price before the company begins trading on a stock exchange like the ASX in the hope that those shares will rise over time.
An IPO normally includes a minimum amount of shares that it requires investors to purchase.
What to consider before you buy
Any company launching an IPO in Australia must lodge a prospectus with the Australian Securities and Investment Commission (ASIC), which contains important information you need to know about the company and the offer.
All current IPOs from companies that have applied to list on the ASX are listed on the ASX website.
It’s important to understand whether or not the stock seems well priced during the IPO process.
To understand whether a business has good prospects and is reasonably priced consider its:
- Long term growth prospects
- Anticipated balance sheet strength after the float
- Predictability of earnings
- Prospects for company earnings and the broader sector.
The IPO process
company has received all the applications from investors to buy shares and closed its offer, it completes a process known as the ‘bookbuild’.
While the prospectus contains an estimated price per share, the book build determines the actual price that the shares will be worth on the day they begin trading.
The bookbuild also determines how many shares will be allocated to each investor.
Once a company has successfully completed its bookbuild, it lists on the stock exchange and its shares can be bought and sold .
Risk versus reward
Investing in an IPO comes with different risks compared with a company that has a long listed history.
Companies may offer shares at what they perceive to be a discounted rate or they may offer some form of added value to compensate investors for the risk of buying shares in an unproven listed company. Never forget that the value of shares can fall as well as rise. once listed.
The company may predict when it expects to make money, but, as with all share market investments, this can depend on many factors, including the global and Australian economy and the future of the relevant industry.
Additionally, not all companies will pay dividends to shareholders – new companies may be more likely to reinvest profits back into the business.