Initial Public Offerings Explained

Initial Public Offerings, also known as IPOs, occur when private companies raise capital by taking themselves “public” from “private”. They are typically very risky because you never know what will happen on that first day of trading. This article will explain the basics behind IPOs, how they work, and what they mean to you as an online stock trader.

IPO Basics

Here are the basic principles behind a company going “public”, which I will explain in more detail after:

  • To go public, a company must first be private, companies like Google, Microsoft, and Apple are all publicly traded companies.
  • Every publicly traded company has a stock ticker. When a company decides to have its IPO, it is assigned a stock ticker / symbol to identify it. Google is GOOG, Microsoft is MSFT, Apple is AAPL, etc.
  • The reason a company has an IPO in the first place is to raise money, or capital. They do this because they want to expand and grow their business.

Those are the basics points behind Initial Public Offerings (IPOs). The process itself in simple terms goes something like this:

IPO Process

  1. Company Blue Shoes (fictional name) is privately held (meaning it is funded with private investors), and has stores in 20 states, but wants to expand nationwide and eventually internationally.
  2. Company Blue Shoes decided to have an IPO to raise capital so it can expand its business.
  3. Company Blue Shoes goes through the IPO process, and raises $100 million in capital as stock shares which will be traded under symbol BSSS (also fictional).
  4. The stock, BSSS, starts trading on May 15th (random date) at an initial stock price of $15 per share.
  5. Company Blue Shoes is now a publicly traded company.

There is a lot more that ties into this process, but in a nutshell this is what an Initial Public Offering is and how it works.

Investing in IPOs

IPOs are very risky. We as the general public cannot buy shares until the first day of trading, and on that first day there is a lot of volatility in the stock price. Sometimes the stocks do very well and can shoot up 10, 20, 50, or even 100+ Percent on the first day of trading. Others though don’t fair to well and can actually lose ground on their first day.

Over the first few months you can get an idea of well a company’s IPO went. For example stocks like Mastercard (MA) and Google (GOOG) did very well there first few months and still are growing strongly today. On the other hand you have companies like Vonage (VG) who’s stock price fell sharply its first few months of trading publicly. In the end, any way you look at them IPOs are risky business, and most of the time it is recommended to stay away from trading on IPO day.

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