Your 60 second guide to IPOs

What is an IPO?

An IPO is an Initial Public Offering. It is the first time a company’s shares are offered for sale to the general public or to institutional investors. Instead of being privately-owned, it becomes a public company and will be listed on a recognised stock exchange. An IPO is also sometimes referred to as a ‘floatation’.

An IPO usually has an ‘offer period’ – a fixed amount of time during which you can invest at a fixed price. When the offer period is over, shares will be allocated and will start trading freely on the stock exchange.

Why would a company float?

A company may wish to raise money in order to finance its growth – either by reinvesting in the business or by acquiring another company. The money could also be used to pay off existing debts.

Sometimes, existing investors in the privately-owned business may wish to simply sell their shares to realise their value.

Another reason for a company to float is that being listed on a stock exchange can improve its reputation. This is because a listed company must regularly report their accounts and trading activities.

Is an IPO a good investment?

Just like any other share purchase, the attractiveness of an IPO will vary from company to company. Investors should consider a number of points before committing their capital. Firstly, read the company prospectus and other supporting documentation, which will detail the financial history, current financial status, intellectual property and other important details including any risks investors may be taking by purchasing the shares.

Other factors to consider are whether the company is selling all or just some of its shares (will the management still have a stake in the business so their interests are aligned with yours?); who is selling and why? Is the long-term strategy for the company clearly articulated? What will the company do with the money they are raising from the IPO? Does the offer price represent good value?

What are the risks of taking part in an IPO?

As with all investments, you may not get back the amount of money you initially invested.

Sometimes you may not know the price of IPO shares before you commit to buy, as the prospectus may only give a ‘range’ rather than an exact value.

Demand is very important when it comes to IPOs. Too little interest may mean that the price of the shares fall once floated or that the IPO is cancelled altogether. Too much demand may result in investors receiving a smaller proportion of shares than they wanted.

Which professional investors take part in IPOs?

A number of fund managers who we rate very highly will invest in IPOs from time to time.  

For example, the team who run LF Livingbridge UK Micro-Cap fund are smaller company specialists, with years of in-depth knowledge around the opportunities in micro, newly-formed and pre-IPO companies. They have extensive experience of investing in unquoted companies and the private equity sector, which gives them an edge over many competitor investment houses.

The team behind the Marlborough UK Micro-Cap Growth and Marlborough Special Situations funds are also specialists in this area, liking to invest in early-stage companies and stay with them throughout their life cycle.

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The views of the author and any people interviewed are their own and do not constitute financial advice. However the knowledge that professional analysts have analysed a fund or trust in depth before assigning them a rating can be a valuable additional filter for anyone looking to make their own decisions.