What to Know About an IPO

by Alexandra Pauline - July 5th, 2012

women investing

IP - Whoa!

Even if you don't know the first thing about the stock market, chances are you got a bit more curious after Facebook's recent IPO. But do you really have any idea what an IPO is? Better brush up now - someday it just might be YOUR company that's "going public!"

So, What Is An IPO?

The term IPO stands for "Initial Public Offering." So, what exactly are they "offering?" They are offering (aka selling) equity (akastocks-trading4-290x193 stock) in their company to the public for the first time (that's where the "initial" comes in). Prior to a public offering, a company is "privately held." So, after an IPO a private company becomes a public company. There are a lot of cooks in the kitchen when it comes to taking a company public, some have strange names like...

The Underwriters

The term "underwriter" or "syndicate" always sounds a little sinister to me! And if you followed the recent Facebook IPO drama, their lead underwriter, Morgan Stanley, was certainly portrayed as a villian in the press. But what is this crucial role, exactly? An underwriter is just an investment bank (or group of investment banks, led by a Lead Underwriter) reponsible for helping take a company public. One of their biggest jobs? To help properly price the IPO! They work with the company to figure out exactly what price a share of stock will be set at on the first day of trading.

Is The Price Right?

auditA lot of the drama surrounding the recent Facebook IPO involved their lead underwriter and accusations that the initial offering share price was too high - thus overvaluing the stock. The thing is, pricing an IPO is both an art and a science - you have to take into account both concrete facts (actual earnings) and the future potential of the company, including intangibles like future product development and innovation. Investment banks make money off what is called an "underwriting spread" - they get big bucks for knowing how to successfully (well, hopefully) price and manage an IPO. The easiest way to explain this spread is just like a mark-up on any sale - if Big Bank buys a share of Hot Company for $1 and sells it to you for $2 - they make a profit of $1.

IPO Dough

So why would a company want to go public anyway? To raise money! In return for the cash infusion, shares are issued to the public which then are publicly traded. The investors' hope is that the price of the stock will rise above the price they purchased it at - but don't expect to turn a fast profit! No matter how frenzied an IPO is, you've got to keep your wits about you! Get Rich Quick? According to financial adviser Michael Hardy, the best strategy when it comes to investing is to think long term. Even though start ups may pop up and explode in popularity in the blink of an eye, DO NOT invest in them thinking you're going to get rich quick. In the current market, the general rule when buying stock is to plan on holding onto to it for a least 5 years. You want to buy low and sell high, but you need to invest in companies with solid growth plans - and then you need to give those companies time for their stock to appreciate. "Flipping" a stock - or buying it in the hopes of immediately selling it for a huge profit - may happen if you get lucky - but is NOT a sound investment strategy!

Playing it Safe - or NotAfrican American woman holding money

The best investors have a diversified portfolio. And you always need to consider your timeline! Younger investors have the advantage of having time on their side to make up for a possible loss, while those close to retirement do not. If you are in the early or mid stage of your career taking a risk could work in your favor - if you can afford to wait. But no matter your age - and no matter how hot an IPO seems - never invest more than you're willing to lose!

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