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How to invest in an IPO
This page explains the key information you need to know before investing in an initial public offering. Learn what an IPO is, whether they make good investments, and read our step-by-step guide on how to invest in one.
What is an IPO?
An initial public offering (IPO) is when shares of a private company are sold to the public on the stock market. Sometimes referred to as ‘floating’ or ‘going public’, once the process of an IPO is complete, a privately held company becomes a publicly traded company. The main reason IPOs occur are for private companies to raise money.
- An IPO is when a privately held company sells shares on the stock market.
- Initial public offerings are a way for private companies to raise money.
- An IPO is underwritten by an investment bank or brokerage firm.
- Once an IPO is complete, a privately held company becomes a publicly traded company.
How does an IPO work?
When a private company decides to go public, the first step to an IPO is for it to select an investment bank that provides underwriting services and advice. Details of the IPO are put forward to a regulatory board who must approve the proposal. Once approved, the private company and underwriter agree on a launch date and share price before the IPO happens.
How to invest in an IPO – a step-by-step guide
Listed below are the steps you have to take before in order to make your first investment in an IPO.
- Identify the stock you want to buy. IPOs happen frequently and deciding which company you want to invest in is the first part of the process. Keeping up to date with the latest financial news is a good way to learn about upcoming IPOs.
- Find a broker that offers IPO access. Not every stockbroker will allow you to participate in an IPO. Typically big institutional firms get the most access, although some brokers offer retail investors the opportunity to buy shares. Asking your broker if they offer access is a good place to start, alternatively searching the internet will help you find one.
- Create an account and deposit money. When you have found a broker that lets you get in on an IPO, you’ll need to register an account with them and deposit funds in order to buy shares.
- Wait for the IPO date to arrive. After you’ve researched a company with an upcoming IPO, you’ll have to wait for the day of its initial public offering. It is a good idea to set up an alert as they can happen suddenly with little warning.
- Decide how many shares you want to buy. You may know ahead of time the anticipated price of each share, so you’ll need to decide how many shares you want to purchase. It’s important to remember that it’s unlikely you’ll get your full allocation, especially for popular IPOs.
- Place your order. Finally, once you’ve completed the steps above, you’ll need to place an order with your broker. After that, it’s a case of waiting for the IPO day to see where the company’s price opens and how many shares you get.
Compare the best place to buy IPO stocks
Most IPO stocks are available through any top online broker as soon as the offering takes place. You can sign up to one in advance by clicking on one of the links below, or scroll down to learn more about IPOs and how they work.
Should you buy IPO stocks?
There is no yes or no answer to this question and a lot needs to be taken into consideration prior to making an investment in an IPO. Many investors like to participate in IPOs as the initial share price can offer good value. However, the flip-side is some companies do not deliver and their share prices drop, losing investors money.
Weighing up the pros and cons of a company is a good place to start and taking into consideration the potential rewards on offer vs the risks can help you make a decision. Not all companies who float on the stock market are destined for success and some fail miserably. However, some do outperform expectations and it can be worth spreading your money across a few IPOs to minimise risks.
Benefits of investing in an IPO
- Value. Traditionally, when a private company lists shares on the stock market those shares are ‘cheaper’ than what they are expected to be worth in the future. Investing in an IPO can provide you with long term value.
- Early stage companies. Many companies that IPO are still in the early stages of their life cycles. Investing in the early stage of a business with a long term outlook offers tremendous growth opportunities.
- Price transparency. The anticipated price per share is clearly noted in the IPO document which is available for all investors to read. The price is the same for all investors, from institutions to private individuals. Knowing the price of a share ahead of time gives you the opportunity to analyse and evaluate it.
Things to look out for when investing in an IPO
Investing in an IPO is different from investing in a publicly traded company that has been around for a long time and requires a different approach. Below we’ve highlighted some of the unique factors to consider when investing in an IPO.
- Price volatility. When a company goes public it’s not uncommon for its share price to experience volatility. Flipping (the process of quickly selling a stock for profit) is a frequent occurrence for IPO stocks and can cause swings in share price.
- Lock-ups. The expiration date of lock up periods is important for IPO investors to pay attention to. When a company floats on the stock market, insiders who own shares prior to the IPO are legally bound to a lock up period. A lock up period is set by the underwriter and stops company insiders from selling their shares for a specific period of time. When a lock up expires, it’s common to see a stock price drop.
- Lack of information. Investing in an IPO requires a lot of research into the company. However, it’s not always possible to conduct well rounded fundamental analysis when young businesses have little public information available.
- Risk. When a company floats on the stock market there is no guarantee its shares will rise. The risks associated with IPOs are high and it can be common for newly listed companies to lose value.
- Hype. Sometimes an IPO can be surrounded by hype and mania, especially for well known companies. If investors buy into the hype, shares can become overvalued and sell offs can cash the value of the shares you hold.
- Valuations. In all public companies, value is a key factor to take into consideration prior to investing and it’s the same for an IPO. Understanding if an IPO stock is over or undervalued can be a difficult task, but an important one. Overvalued IPOs tend to drop quickly, while undervalued shares offer growth potential.
Not every business that wants to go public goes through the process of an IPO. There are other options available to private companies which we’ve briefly explained below.
- Direct listings. This is when existing investors in a private company agree to sell some of their shares to the public on the stock market. Direct listings don’t issue new shares like an IPO. Intermediaries are not used either and the lack of institutional investors who lock in large amounts of money to stabilise the price in an IPO can result in volatile conditions.
- SPACs. A special purpose acquisition company (SPAC), is an empty company with no commercial operation, purely set up in order to purchase another business. SPACs are usually created by institutional investors who then raise money before acquiring or merging with a private company wanting to go public. Investing in a SPAC is risky because you don’t know what new business will be acquired. However private companies may choose a SPAC deal as it’s much quicker and cheaper than an IPO.
When can I invest in an IPO?
A company looking to float on the stock market will choose an initial public offering date which will be made public ahead of time. Although, often an IPO date is only confirmed very shortly before the date. You are able to keep track of any companies going public by monitoring their websites and stock exchanges.
Can I buy an IPO before it goes public?
Sometimes you can, but it’s unlikely that you will be able to. Buying an IPO before it goes public is generally reserved for institutions, high net worth investors, and employees of the company. Below you’ll find a couple of ways in which you can invest in a company before it has an IPO.
- Specialised broker. Some brokers take part in pre-IPO trades and then offer stock to their clients. Asking your current broker if they offer this service, or finding a broker who does is a way to buy pre-IPO stock.
- ETFs and public companies. This method offers an indirect way to invest before a company goes public. There are a small number of ETFs that specialise in private equity which you can easily buy shares in. You also have the option of investing in a publicly traded company that’s in the business of investing in private companies.
- Direct investing. Some companies offer shares to customers before going public. While this is not a frequent occurrence, it does happen at times. Most recently, financial broker Robinhood opened up some shares to people who were using their app.
When can I sell an IPO stock?
You’re able to sell an IPO stock as soon as it starts trading on the stock exchange. That is unless you’re bound by restrictions. However, restrictions are normally imposed on people who buy ahead of time or work for the company.
When a private company goes public, it’s common for founders, early investors, and employees to own shares in the business prior to it floating. Rules restricting this group of people from selling shares immediately are put in place to protect new public investors from sudden drops in share price.
A quick recap
Buying an IPO stock can offer very good returns for individual investors, but they’re risky. Prior to investing in an IPO, you will have to understand the company, which at times can be difficult as it is private. A lot of research and homework is required, but the potential for getting in early can be hard to pass up.
It’s difficult to buy shares pre IPO, and finding a broker that offers initial public offerings is the first step to take. It’s important to remember that most companies on the stock market had to IPO at some point in their history and it only takes one or two good investments to make a vast sum of money. That being said, IPO investing is best suited to experienced investors.
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