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An Introduction to IPOs

What are IPOs? Why would companies decide to "go public"? Find out below.

The stock market is undoubtedly one of the largest markets in the financial world. It contains thousands of stocks you can choose to invest in. And private companies also mean to offer what they have by issuing an IPO.

HQBroker - Initial Public Offering on market board LCD screen

Private companies nowadays issue IPOs in hopes of making the company grow bigger. They hope to partake of the better circumstances that public companies have especially in online trading.

But just as the saying goes, there are two sides to a story. There are positive outputs that companies stand to gain by issuing IPOs, and there is also the negative side.

Read more about the different types of stocks in the market.

Before we discuss the pros and cons, let’s clear things up, what exactly is an IPO?

What are IPOs?

Initial Public Offerings, or IPOs, are the very first sale of stock issued by the company to the public. They are also referred to as “going public”.

Before a company issues an IPO, it is considered to be private. A private company has a relatively small number of shareholders mostly consisting of early investors, and professional investors. These include founders, their families and friends, and venture capitalists or angel investors.

A public company on the other hand consists of everyone else. This involves any person or institution who wasn’t previously part of the company during its early days. if you find yourself interested in buying shares of the company, you can then buy their IPOs.

Unless a private company sells their share to the public, the public will not be able to invest in it. You can try to approach the company and ask them about investing in their company. But they are not obligated to sell you anything.

Meanwhile, public companies need to have sold at least a portion of their shares to the public to be traded on a stock exchange.

Learn more with tips to help you before starting stocks investing.

An introduction to IPOs

Why Companies Issue IPOs

Upon issuance of an IPO, the company will become public. Going public has its own advantages and disadvantages, and for those who decide to push through, the pros they found outweighed the cons. But more on this later, now back to our topic. Why go public, then?

A company going public stands to gain a great deal of money for the company. This is because going public has that exact purpose, which is to help the company grow and expand.

Private companies do have options for raising capital, such as borrowing, finding additional private investors, or acquisition. Despite this, the IPO option raises the largest sums of money by far for the company and its investors.

More financial doors also open with the company going public. Public companies receive increased scrutiny from analysts and investors making them enjoy better interest rate when issuing debt.

Market demand also makes it possible for the company to issue more stock, also known as secondary offering. This makes mergers and acquisitions easier to arrange since stock can be issued as part of the deal.

HQBroker - IPO Illustration megaphone concept

Pros and Cons of IPOs

IPOs are usually an exciting time for the company. This means that the company has become successful enough to need more capital to continue its growth. But like everything else, there are positive and negative sides to a company issuing IPOs. Here are some of their advantage and disadvantages.

Advantages

To the company:

  • Issuing an IPO is usually the only way for a company to generate enough money for a massive expansion.
  • For the owners, this means that they can finally cash in on all their hard work. Normally, owners will reward themselves with a significant amount of stock.
  • Owners stand to gain million the day their company goes public.
  • Gives the company the opportunity to attract top talent because of stock options offering.
  • Executives will get paid little wages upfront while promising opportunities to cash out later with the IPO.
  • Public markets and liquidity can give the company the opening to implement more and better benefits. Things like employee stock ownership plans (ESOPs) can be issued, helping attract top talent.

To investors:

  • The initial shares are only available to those who know of its existence, making it more sought out.
  • As an investor, you will have the chance to start from the ground up. This is good since IPO shares can often skyrocket in value when they are first sold on the stock market.
  • The open markets offer better liquidity. This can make valuing and selling of shares much easier than when the company was private.
  • In the long run, potential profit for an IPO has the chance to grow bigger. Potential profits can sometimes reach more than 100 percent, depending on the performance of the share.
  • It does not restrict you to long-term investment plans since there are also potential short-term gains. If a share does better than expected, you can easily double or triple the IPO price in a short period of time.

Disadvantages

To the company:

  • The process of issuing IPOs requires a lot of work. This can distract the company leaders from the business and hurt the profits.
  • Investment banks, like Goldman Sachs or Morgan Stanley, must be hired to help the company make the complex process easier. These banks are expensive.
  • Business owners might not be able to keep as much shares as they wish. Original investors might require the owners to put all the money back into the enterprise.
  • If owners are able to take as much as they want, they might not be able to sell them for years. Selling huge blocks of shares might lead to investors believing that the owners are not confident of their own business.
  • Ownership of the company might be completely removed from the originals. A Board of Directors can even go as far as firing them.
  • Heavy scrutiny from regulators.
  • Competitors can gain vital information about the company once the business goes public.

To investors:

  • Usually, there is a clause that prevents you from selling your stock. This is particularly disadvantageous when an IPO’s value rises then plunges just a few days later.
  • There isn’t much information regarding the shares’ performance. New-to-market securities don’t have the historical performance or data that publicly traded securities are required to offer.
  • It can prove to be harder to predict how the company will perform post-IPO.
  • IPO can get overvalued due to attention gained from media or a market boom. This may influence your thought process regarding the IPO, clouding your judgment.

Conclusion

As mentioned, going public has two sides, the positive and negative sides. But just like what you’ve read, a company’s decision to go public will not only affect he business itself but also the investors.

There are various factors that should be considered when issuing an IPO. Both the company, and you as the investor, should think hard upon issuing or buying of IPOs. Reading more about the topic you’re curious about will help you make a choice.

Just don’t forget to study before making any final decisions.

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