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Ask a guru: What’s an IPO?

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Initial Public Offering 101

If you have been reading any financial media, or even social media, at all throughout 2020, you likely get the feeling that the IPO market has been growing like crazy. This is something my colleague, Ishan Dan, has addressed in his article this week, called IPO market review – who delivered in 2020?

As a step back from the headlines, we thought it was worth offering some insight into the IPO (initial public offering) market and why so many companies are heading down this route. Despite the regular use of the term, we have found many clients, investors, and people in general, may not fully understand its purpose or role in global capital markets.

So, what is an IPO?

Put simply, it is the process through which ‘private’ companies offer shares in their business to the general public. The general public is then able to buy and sell these shares via a registered stock exchange, like the ASX or New York Stock Exchange (NYSE), for example.

Why do companies do an IPO?

Most companies do an IPO because they need more money. But this doesn’t have to be a bad or a good thing. The purpose of an IPO is to expand the number of shareholders in a company and in effect, offer that company access to other people’s money in order to grow their business, acquire other businesses or in some cases, buy out an existing shareholder.

A perfect example would be say a meal kit company which is currently producing 400,000 meals per day, but has a demand for one million meals. In order to meet this demand it will require a new factory, but having invested every dollar of their money into the business, the shareholders need some additional capital to fund the expansion. In return for funding this expansion, the shareholders then receive a share in the profits (and losses) of the company, in perpetuity.

In most cases, companies seeking to IPO are growing quickly, and need to make a major investment or are even looking for some external support to assist in guiding their business. In other cases, they may be seeking to cash-out, as in selling a share of a business they have spent years building, to move onto something else.

How do companies IPO?

In general, most companies do an IPO through the most traditional route, by engaging one or a number of stock broking firms to assist in finding investors to raise the amount of capital they require. This includes roadshows, presentations, and constant pitches for investors, with the wider the spread, generally considered a better result.

The pricing of an IPO is then determined by a mixture of factors, but primarily the demand for the company’s shares. It will be priced based on a comparison to similar businesses, both in Australia and around the world, and then each broking firm will undertake a “bookbuild,” through which bids are made for parcels of shares, and this process ultimately determines the offer price.

Why don’t all companies IPO?

The process of moving from a private to a public company is a complex and expensive one, hence it is not suited to every business. In fact, many fast-growing technology businesses prefer to stay unlisted in an effort to avoid the pressures that come with making all of your financial data public. Listing on, and then remaining on, an exchange requires the constant and timely disclosure of all material factors relating to a company, a number of listing fees and an increased level of regulatory compliance.

What is a pre-IPO?

One of the fastest growing areas of the market in recent months has been the pre-IPO sector. This simply refers to companies that aren’t quite ready to mount their IPO and need some more money, and stronger growth, before they are ‘ready’ to IPO, in say, 12 months’ time. These capital raisings are made into private companies, with less disclosure required, but are similarly facilitated by stock broking firms, and are usually at a 20%-30% discount to the eventual IPO listing price. 

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