What’s an IPO, and How Does it Work?
By Elliot Ries
An IPO — or “initial public offering” — refers to the process a company goes through to issue shares, or stock, on a stock exchange.
Through this process, a privately-held company “goes public” by issuing stock on an exchange, which anyone can purchase, and which allows the company to raise capital through the primary market by offering those shares (or bits of ownership).
In short, a company goes public in order to raise more money, and it means that all investors will have the opportunity to buy the company’s stock on a stock exchange.
An investment bank assists as an underwriter when taking a company public. For a company that wishes to IPO, the first step is to file the proper paperwork with the SEC, then the investment bank will introduce the company to large institutional investors, like pension funds, that can purchase shares before it is listed on an exchange at the “IPO price,” which is called the IPO allocation. For small retail investors (like you or I), it is nearly impossible to get a part of this IPO allocation, meaning it is nearly impossible to buy a company’s stock at its initial IPO price.
Keep in mind that this is a brief overview of the complex IPO process. There are many more steps and considerations involved, and there is a lot more that goes into each step of this process, so be sure to do more research if it’s a topic that interests you.
IPO example: Snowflake
Snowflake is a cloud-based data warehouse company that, last year, had the largest software IPO in history (at the time). The company is backed by Salesforce and Warren Buffett’s Berkshire Hathaway, which have invested $250 million $480 million in the company.
The day the company’s stock hit the exchanges, Snowflake’s share prices surged, and prices shot up to around $245 — significantly more than the starting price of $120. Individual investors can buy shares at the market opening after the large institutional investors get their opportunity to place their orders.
Retail investors will typically have to wait until the stock is available on the exchange, rather than institutional investors who get their shot before market IPO allocations.
Remember: Investing in a newly public company is risky. Investors with a lot of capital, or money to play around with, can better stomach that risk and absorb any losses. But for individual investors, a significant loss can do great damage to your portfolio. So, be careful not to get caught up in the IPO-hype, and make smart decisions with your money.
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