Investments are designed to generate earnings for investors in exchange for the risk they expose themselves to in making the investments. Corporations often ask for money from investors to ramp up their operations, buy expensive fixed assets, pay for wide-ranging repairs or upgrades that are better off all done at once, and otherwise serve their interests well — that’s the magic of the initial public offering (IPO).
What Is an IPO?
First, it’s necessary to revisit the idea that investments earn money because fund managers or, in this case, major corporations, use them together with heaps of other investors’ money to take advantage of economies of scale. If you don’t already know, no investment is safe; if you can’t afford to lose money, you shouldn’t invest it if tempted to make a quick dollar “if everything goes right” — this ideology is a near-surefire form of disaster.
Drumming up money to directly fund the expansion or improvement of operations isn’t the only purpose of initial public offerings; also, know that there usually isn’t just one reason for carrying out an IPO — a couple of popular reasons below will be in the minds of companies’ decision-makers when they decide to go through with those initial public offerings.
Arguably the next-most popular reason for an IPO is to prepare for a merger or acquisition in which the shares are often used to pay for those usually-pricey M&As. Right up here neck-and-neck with the first two comes to the third major reason for planning, registering for, and carrying out an initial public offering — in hopes of boosting the value shareholders might get from owning stock in the company.
Less commonly, any involved private equity or venture capital outfits may raise awareness for an IPO just to relinquish their ownership of the company at hand.
The Intricate Mechanics of the Initial Public Offering
From their creation until they morph into a true publicly-traded company, companies are private. Private businesses that grow large enough to even consider going through the initial public offering process got to that point with just a few, or at least a relatively small number, of shareholders. These usually take the form of family and friends, as well as company employees who were hired early on and showed a drive to reach upper management or executive position.
Higher-ranking workers are especially likely to award themselves or be awarded bonuses and other extra-favorable forms of treatment, something that can kick off a series of seismic waves that may upset mid-level and lower-ranking employees for some time. According to Money Morning, “In January, there were plenty of rumors of generous employee bonuses floating around.” Ultimately, this definitively caused issues witH the Palantir stock pricing on down the road.
Are IPOs Good Investments?
Back before the dot-com bubble burst over 20 years ago, many investors were more than willing to hop all over initial public offerings in hopes of striking it rich. Now, however, most investors care about the long-run potential of publicly-traded stocks. To put it simply, initial public offerings can be good for investors and financial advisors willing to take more risk; they’re typically best left along by the safer, long-term crowd.
How Are They Priced?
In order to arrive at a legally-allowed initial public offering price, an underwriting company must carry out due diligence in their underwriting. Half of the shares owned by the company go to stock exchanges to be sold to the public, whereas the part-owned by the private shareholders stays right there and becomes the same price as those on the publicly-traded stock market.
Initial public offerings are an inherent part of becoming a public company. They offer many great opportunities, but not just anybody can get in on those benefits without assuming more risk than most people are looking for.