What Is an Initial Public Offering (IPO): How Does It Work?

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People want to know what an initial public (IPO) offering is and how it works.


An Initial Public Offering is an exclusive chance to purchase stocks before they become available on the exchange. Investors can benefit by buying low-priced stocks before they get expensive when brokerages enter the trade.


As the stock prices become highly volatile on the launch date and shortly afterwards, investors can take advantage of the price fluctuations.

This comprehensive guide teaches you the ins and outs of an IPO, including the IPO process, how it works, its types, pros and cons, and tips to apply for it.


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1. What Is An IPO, And How Does It Work?


IPO is a means by which private companies raise their capital. They list themselves on the Australian stock exchange and 'float'/sell their shares to the public, including retail and institutional investors.


Thus, an IPO allows a private company to access a large pool of investors' capital to expand its business, pay down its debt, or use it as working capital.


Usually, younger and growing companies raise IPOs to expand their business or large privately owned companies that want to trade on the public market.


A successful listing accelerates growth and opens up new business opportunities. It improves the liquidity of a company's stocks in the public market and enables the management to offload their current stocks without requiring a private buyer.


Investors can access shares in an IPO directly or through your broker. After an IPO, the company gets 'listed' on the exchange, and its stocks become available for the public to trade.



2. What Does IPO Mean On ASX?


A private firm lists itself on the Australian Stock Exchange as an Initial Public Offering (IPO) for the first time and becomes a public company with public shareholders.


It enables the company to use public investors' money to increase its equity capital to meet its financial goals.


The company determines the number of stocks it wishes to offer, and a designated corporate adviser or investment banker proposes the initial stock price based on projected market demand.


3. What Are The Reasons Behind Companies Going Public?


When a company grows beyond a specific size, investors find it challenging to continue running the operations within its capacity. The companies need a continuous flow of capital, which many private companies need help to afford.


In such a case, investors can choose to sell the company to another company where they can find opportunities for collaboration and merge or raise an IPO to get extensive public participation.


An IPO helps a company strengthen its public profile and improves credibility among creditors, suppliers, and customers. Here are a few more reasons a company may consider offering its shares to the public:


  • IPO provides cheaper and quick access to capital to a company

  • It improves the revenue generation of a company.

  • Founders of the company can use an IPO to acquire other companies for quick expansion or to strengthen their market position.

  • Some companies even look to raise capital to pay debts, monetize assets, or attract and retain talent. 

  • IPO also allows the company to use its stock as currency.



4. Advantages Of Raising an IPO


An IPO can lead to a considerable windfall due to the sale of its ownership. The company can use these funds for various activities such as expansion, acquisitions, debt repayment, etc.


Other benefits of getting listed on a stock exchange are:


  • Offers a broader exposure to public investors to raise future capital

  • It helps improve the public image of a company

  • May improve the sales and profit of a company

  • Allows initial investors to exit by selling their holdings for a period after listing 

  • As opposed to privately traded shares, IPO makes it easier for traders to buy publicly traded shares easily.

  • Traders can invest in a company's stocks or securities before it gets listed on the stock exchange.

  • Most companies that bring IPOs also pay dividends or interest to their investors.

  • Public investors can save money on tax as they receive dividends after tax deduction at the source. 

  • Lower capital cost for debt and equity



5. What Are The Disadvantages Of an IPO?


Besides the advantages, there are some drawbacks of IPO for a company, such as:


  • A direct listing on the exchange involves substantial expenses such as accounting, marketing, legal, and listing fees.

  • They have a continuing requirement by the stock exchange to reveal financial, accounting adequately, tax, and other business information.

  • There is always a risk that the company won't be able to raise the required capital. 

  • Raising an IPO requires considerable effort, time, and attention from senior management.

  • IPO can result in loss of control for the company's initial investors due to dilution and the need for stockholder's approval as per the ASX Listing Rules


Drawbacks Of IPO Investment For An Investor:


  • There's no assurance that the value of the stock will rise or maintain its value after going public. Sometimes, when the stock price is over-priced, or the initial investors dump the shares after the lock-in period, it can result in a fall in value. You may lose some or all of your money in such a case. 

  • IPOs with weak fundamentals may have low liquidity, making it easier for investors to sell the stocks.

  • Some companies decide not to pay dividends to their investors.



6. What Is The Initial Public Offering (IPO) Process?


 The process of an IPO involves a series of steps in Australia:



Step 1: Prospectus


The company prepares a prospectus and lodges it with ASIC. The prospectus contains information about the IPO that helps investors make an informed investment decision.



Step 2: Application


The company decides the entities for the allotment of its shares and their percentage allocation. Usually, IPOs are open to customers, the general public, and institutional investors.


They can apply by filling out the application form in the prospectus or through a broker participating in the IPO.



Step 3: Allocations


After the company receives the applications, it will start stock allocation. An 'oversubscribed' IPO implies that the company has received more applications than an individual category's allocation limit. If this happens, you may get fewer shares than you applied for or even none.



Step 4: Listing


Once the company does the allocation and receives the application and money from the public, it lists the new shares on the stock market. They trade just like any other stock on the exchange based on their supply and demand.



7. How Do IPOs Work In Australia?


Launching an IPO is the first step for a private company to go public and sell its shares on the stock exchange. They conduct an audit to consider the different aspects of a company's financials, such as:


  • Defining its financial goals

  • Analyzing how much it will require to raise at the IPO

  • Identifying what securities it will offer as well as their initial listing price


If things are in order, the company lodges a registration statement or prospectus with the appropriate exchange commission like ASIC. It contains essential information about the company and the offer.


The commission reviews the application, and decides whether it accepts it, needs certain amendments, or rejects it completely. Once the ASIC approves, the company lists a defined number of shares for sale on the appropriate stock exchange, i.e., ASX.



8. Types Of IPOs In Australia


Top stock brokers like ANZ Share Investing allow you to access two types of IPOs.


  • On-Market IPOs – You buy stocks in smaller or younger companies via ASX BookBuild.


  • Off-Market IPOs - You invest in the largest and most established companies in Australia via stocks, hybrid securities, or interest-rate securities. 



9. Can Anyone Invest In an IPO?


Yes. IPOs are usually open for retail and individual investors. However, investors may have a limitation on the number of shares they can buy, or they may have to buy a minimum number of shares to apply for an IPO.


To apply for an IPO, retail investors must open a trading account with a stockbroker participating in IPO. This way, you can access all the upcoming IPOs.


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It is important to note that you need more than applying for an IPO to get the shares. If the IPO is oversubscribed, the company may allocate you fewer shares than you have applied for.

Investors who can't invest in an IPO in the pre-listing stage can still buy the share once it gets listed on the exchange. However, you may not get listing gains but may take advantage of the high price volatility in the initial days of listing.


If you believe in the business and its fundamentals, you can hold the shares long-term and benefit from long-term business growth and stock price appreciation.



10. Steps For Listing A Company On ASX


ASX is the primary exchange for listing stocks and securities in Australia. It considers its market's integrity, efficiency, and reputation to decide whether to accept or reject any application for admission to its official list.


Here are the listing rules a company has to comply with to get listed on ASX:


  • It should have a proper structure and operations for a listed entity. 

  • It should complete an In-principle Suitability Application before embarking on the IPO process.

  • Under the Listing Rules, the company must regularly disclose its business and financial information to the exchange.  

  • After listing, a company must inform ASX immediately of information concerning any reasonable person who would have a material impact on the stock's price or value



11. How Long Is The IPO Process?


The time required in the IPO process varies based on how well it is coordinated and managed. The process starts with a lengthy financial audit that can be more time-consuming if the company's ledgers are in order.


The next step is to prepare a registration statement to lodge for the IPO. Once that is done, the stock exchange takes its time to review the application. If it finds any concerns, it may delay the approval process.


Usually, a well-managed IPO takes around 12 months, but it can even take more, considering the complexity of the business.



12. How Much Does An IPO Cost?


The cost of launching an IPO depends on the registration requirements of the stock exchange where it gets listed.


Companies have to bear the cost to list themselves on a stock exchange, such as accounting fees, legal fees, listing fees, underwriting fees, and offering costs.


Larger companies may need to pay additional costs when preparing to list.



13. Do IPOs Ever Fail?


Yes. There are several initial public offerings examples where they have failed for one or more reasons listed below:


  • Stock is overly priced

  • The entry into the market needed to be corrected. 

  • The company's fundamentals need to be revised.

  • The business isn't feasible. 

  • Debts were more than earnings.

  • Continuous selling by promoters. 


There could be a few more reasons, too, but these are the significant points why an IPO can fail after listing.



14. Is IPO Investing Good For Beginners?


New investors often find it exciting to buy stocks before they become widely available, hoping to make quick gains when they start trading.


But not all IPOs (Initial Public Offerings) are winners. In fact, only about 3 out of 10 tend to do well. Instead of getting carried away by the excitement, beginners should focus on checking if the company is strong.


It's best to invest in companies that are already successful and have a good outlook for future growth.


In addition to understanding the financials, they must also study the disclosure documents to know the investment terms, reasons behind the IPO, lead brokers, and other key things.


Additionally, they need to know when it's the right time to enter the market, keep an eye on the global economy, and be aware of any industry-specific shifts that might influence an IPO's performance.


Valuing a company using traditional valuation metrics is another demanding task they must do when pursuing an IPO. It is essential to look at the company's revenue growth, brand strength, and customer retention to estimate its profitability in the future.


Beginners should know that getting their hands on an IPO can be difficult as most popular IPOs are often sold mainly to institutional and wholesale investors.


You must have access to a full-service broker to access IPOs if they have an available allocation.



15. Conclusion


Investing in IPOs can be a good chance, but you need to be patient.


Getting carried away by excitement or the fear of missing out can lead to bad decisions.


If the company you want to invest in is strong, you don't have to rush to buy its shares right away.


You can wait a week, a month, or even a year. There's no need to hurry.


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The advice and information on OzStudies.com is in general nature and should not be seen as a replacement for independent financial advice. We strongly encourage readers to consult with financial experts regarding their own financial decisions and investments.

Please note that the information presented on OzStudies.com is solely for educational purposes. Every individual's financial situation is unique, and the products and services we mention may not suit everyone. We do not provide financial advice, advisory, or brokerage services nor endorse buying or selling specific stocks or securities. It's essential to know that information might have changed since publication and past performance does not guarantee future results.


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