What is an Initial Public Offering (IPO)?
This means the company can raise money from public investors. After the IPO, stockholders can then resell their shares on the stock exchange.
An IPO can only be initiated when a company reaches unicorn status – a valuation of $1 billion. It is an exciting step for a company and it can spark a lot of excitement and adrenaline from retail investors and financial experts alike. The advantage being that it quickly generates significant portions of capital to the business, which is beneficial to both the returns of early investors and the company as a whole. But there is a lot of risk involved when investing in IPOs so it is important to proceed with caution. But more on that later…
KEY TAKEAWAYS
- An IPO is when companies with a valuation of $1 billion or above initially makes stocks available to the public
- It's the main way companies with high growth potential can raise money from public investors to fund their business
- Typically, IPOs are only open to institutional investors, such as insurance companies and pension funds, or high-income retailers
- By investing in an IPO, you can make significant sums of money by catching the company early on and when shares are at their lowest price
- Individual investors can't invest in IPOs, but can buy an IPO share at an opening price in the secondary market from other investors
How do you invest in IPOs?
Typically, IPOs are only open to institutional investors, such as insurance companies and pension funds, or high-income retailers because they require some form of connection to the company in question. This means individual investors – investors like us – unfortunately usually don’t have access to IPOs. That being said, individual investors are able to purchase an IPO share at an opening price in the secondary market which means you’d be purchasing the shares from investors, rather than directly from the company.
Pros and cons of investing in IPOs
Like any form of investing, IPOs come with their own set of advantages and disadvantages.
Advantages
- Quick returns: Investing in an IPO means you’re catching the company when it has high growth potential. This means you can expect to generate a good return on investment and see digits double and maybe even triple in a short time span.
- Transparency: Since the purchasing price is pre-determined with an IPO, the purchasing price of each security is clearly defined and therefore doesn’t fluctuate. This price is therefore the same for anyone investing in an IPO and is set out in a document that is distributed to institutional and individual investors.
- Long-term goals: If you decide to invest in IPOs, they are a great way to meet long-term goals, such as retirement plans and buying a property, because leaving the money for a long period of time can see even greater returns than the initial quick wins.
- Buying low: An IPO means you buy shares in the company at its lowest price, which therefore gives you more opportunity to make rapid returns as more people gradually invest. However, missing the IPO opportunity – which most of us wouldn’t have access to anyway – means you have to buy when the stock price has increased.
Disadvantages
- Fluctuating prices: Volatile price fluctuations make it a very uncertain and unsettling investment. When the prices plummet, it’s never a pretty sight. So it’s wise to proceed with caution as it could damage your portfolio if things go wrong.
- Time consuming: There’s a lot to consider when investing in IPOs and you need to ensure your decision is as informed as possible as a lot of risk is involved. That means spending a wealth of time looking through the company’s past performance and documentation. A lot of that can be complex information that can get your head in knots, so it may be a less appealing investment opportunity.