How Does an IPO Work?
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An IPO or Initial Public Offering occurs when a private company offers up shares of its company for sale to the public, who by purchasing those shares own a piece of the company. Small private companies carry out IPOs to raise capital for growth and expansion, while well-established private companies have IPOs to become publicly traded and even bigger. For example when Rupert Murdoch's News Corporation went public, it sold about a 19% stake of the company to raise almost $3 billion.
Investors who buy a company's shares buy a piece of ownership in the company for a chance to benefit from its future profits. For the owners of a company, it means giving up some control depending on what percentage of the company is sold, opening the company up to public and government scrutiny, and being accountable to shareholders.
When a company decides to offer an IPO, it hires an underwriting company or companies which are usually investment banks that take on the task of researching the company about to go public, marketing the company and ultimately issuing and selling stock.
Once the underwriters have completed their research they take the company they are about to sell on a road show of presentations and sales spins to convince institutional investors and analysts to buy into the IPO. These large investors and not individuals are the ones who will do most of the buying and raise the company the most money. It is therefore no accident that average Joes are not invited to participate in an IPO before the first
day of trading.
The best way to get in on an IPO as in individual small investor is to contact your broker or have a brokerage account at one the investment banks serving as underwriters for the IPO.
After all the hype and publicity, the company chooses a date for the IPO offering. The shares are usually offered to institutional investors and big buyers through an auction process.
After this, trading takes place for the first time on the open stock market at a starting price decided as the issue price. Depending on how well the first day of trading goes the company is able to meet its initial projections of how much capital it is expected to raise.
Not all experts agree that investing in IPOs for individual investors is such a good idea. One reason is because individuals are encouraged to hold onto their stock for at least a month before selling, unlike institutional investors who can buy and sell whenever they want. Because of the hype surrounding an IPO, the stock price usually rises heavily in the first few days of trading and then tapers off or even falls. At the initial stage, the institutional investors can move in and out and make a killing.
For the individual investor, especially one interested in investing for the long term, the best time to buy is not necessarily at the IPO stage but when the excitement has waned off and the price has fallen. A month or two later will be just as fine. Of course there are rare exceptions.Source: ehow.com