If you’ve heard of an up-and-coming stock or a company that is likely to go public in the near future, you may be wondering how you can get in on the ground level. One way to do this is to invest in the company’s IPO.
When you invest in an IPO, there are unique factors that you must consider like the logistics of purchasing and the additional risks associated with buying a brand-new stock. By understanding these factors, you can approach IPO investing with confidence.
What is an IPO?
IPO stands for Initial Public Offering, and it is the process by which a company transitions from private to public ownership. It involves the first sale of company stock and is overseen by the Securities and Exchange Commission [SEC].
Companies go public for many reasons, but the most common one is to raise a significant amount of capital at one time through the initial sale of stock. To do this, the company needs to follow a lengthy process starting with underwriting.
An underwriter analyzes the company’s value – typically using the principles of fundamental analysis – to arrive at the company’s stock price. The shares are then marketed by the company and underwriters and paperwork is filed with the SEC.
Prior to the IPO, the company must put processes in place to meet the requirements of a public company – like regular filings with the SEC. Finally, the shares are issued on the IPO date.
Why Would You Want to Buy An IPO?
There are two main reasons to invest in an IPO. The first of these is to buy a stock you expect to grow in the future. The capital raised through an IPO can be integral to allowing a company to invest in growth projects and can lead to future expansion. In turn, the stock price could rise and provide a boost to your portfolio.
The second reason to invest in an IPO is to take advantage of volatility short-term surrounding the IPO. The period during which a company first goes public is often characterized by large swings in the stock’s price as investors digest the company information and settle on a fair price.
If investors determine that the underwriter’s estimations valued the company too low, you could capitalize on gains in the short-term. On the other hand, the volatility surrounding the IPO could also lead to significant losses.
However, many IPOs require initial investors to agree to hold their shares for a certain amount of time. These “lock-up” periods could stop you from selling your shares for a set period of time following the IPO – preventing you from capitalizing on short-term gains or capping your losses.
How To Buy An IPO
IPOs generally generate a lot of attention, and there is no guarantee that everyone who expresses interest will be able to buy shares. In most cases, the majority of shares are bought by institutional investors – like asset managers and hedge funds. However, there are cases where regular investors are able to purchase shares, but these are not as common.
Depending on the company, your net worth, and your investing experience, you may be able to buy an IPO through your brokerage firm. This usually involves a special process that requires you to state interest before the IPO occurs.
Other Methods for Investing in New Stocks
Because it is often difficult for individual investors to participate directly in an IPO, you may need to turn to other methods to buy new stocks. One option is to purchase a mutual fund or ETF that specializes in IPOs. The managers of these funds are often large enough to purchase shares in an IPO and can allow you to share in both short and long-term gains from these stocks.
Another method to invest in a newly public company is to participate in a program like Robinhood’s IPO Access. These programs allow you to buy a new stock at the IPO price once it’s available to the general public. The shares are made available to participating broker dealers from investment banks who participate in the IPO.
A third option to invest in an IPO is to wait until the shares are being resold on a stock exchange and buy them at that time. This allows you to gain many of the benefits of an IPO – like purchasing the stock at the ground level for long-term growth. On the other hand, you may pay a price that is much different than investors paid during the IPO.
As with all investing moves, whether to buy a stock at the IPO, invest in an ETF, or wait and purchase a stock after the IPO is an individual decision. It should be made with your unique goals and risk tolerance in mind and only after discussing your needs with an experienced financial advisor.
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