What is an IPO and How and Why are Investors Buying in?
By: Arlene Pelley CFP, CIM, FMA, FCSI
IPO Basics: What is An IPO?
Tim Hortons — Canada's largest coffee shop chain — steamed up North American stock markets when it went public last month by offering its shares to investors through an Initial Public Offering, or IPO for short. The media attention focused on what is the largest IPO so far this year, has prompted many investor questions on the basics of IPOs. With that in mind, what follows is a quick primer.
Going Public
Companies fall into two broad categories: private and public. Private companies do not sell shares to the public. Public companies, on the other hand, have sold at least a portion of the company to the public and shares are traded on a stock exchange.
Why A Company Chooses To Go Public
Becoming a publicly traded company opens many financial doors and raises a lot of cash for a company. Public companies can usually get better rates when they issue debt and as long as there is market demand, more stock can be issued by the company. Trading in the open markets means liquidity. And the companies can implement things like Employee Stock Ownership plans, which help attract top talent. Considerable prestige is also carried when a company is listed on a stock exchange. In addition, a publicly-held company is more likely than a private company to be followed and reported on, and offers financial reports that can help build brand awareness.
The Underwriting Process
IPOs are usually offered to the public through an "underwriting syndicate," a group of broker dealers who agree to purchase the shares from the company (the issuer) and then sell the shares to investors. Only a limited number of broker dealers are invited into the syndicate as underwriters and they may not receive equal allocations of securities for sale to their clients.
The underwriters, in consultation with the company, decide on the basic terms and structure of the offering, including the percentage of shares going to institutional investors and to individual investors, well before trading starts. Most underwriters target institutional investors in IPO distributions as they believe that they are better able to buy large blocks of IPO shares and assume the financial risk and hold the investment for the long term.
It can be a long and sometimes complicated road to an IPO. As an individual investor, you are not involved until the end of the process. The only way for an individual investor to get shares of an IPO is to have an account with one of the investment banks (dealers) that form part of the underwriting syndicate.
Things to Consider Before Buying
IPO companies can be tricky to analyze since there isn't a great deal of historical information available. The Prospectus will be the main source of information and data. This is a legal document required by securities regulators. It must explain the offer including the terms, issuer, planned use of the money, historical financial statements and other information that could help an individual decide whether or not the investment is appropriate for him/her. You can obtain one from your financial advisor or visit www.sedar.com to find the company's public documents. Pay particular attention to the management team and how they plan to use the funds the IPO generates.
When an IPO is "hot" and appeals to many investors, the demand for the securities far exceeds the supply of shares. The excess demand can only be satisfied once trading in the IPO shares begins. Because of the active trading when the IPO is first issued, a good rule is not to buy shares of an IPO if you don't get in on the initial public offering.
You May Want To Avoid The Hype
Investing in an IPO can be a risky and speculative investment. Every month successful companies go public, but it is sometimes difficult to find the ones with the most potential. Some investors who have bought stock at IPO prices have been rewarded quite handsomely while others have been disappointed.
In conclusion, when it comes to dealing with the IPO market, be cautious and informed. Advice from a professional is recommended before considering an IPO as an investment.
|
are certification marks