How does a company become publicly traded? Everything you need to know about IPOs

Chris Broome – Chartered Financial Planner

Perhaps you already invest in the stock market in some way, and find out about companies selling shares for the first time via the news.

But what actually happens during an IPO (initial public offering), and which parts are important for investors to pay attention to?

Read on to find out.

Idea to IPO

IPOs present the first opportunity for investors to invest in a company

An IPO is one of the methods that companies use when their stock becomes available to investors. Publicly issuing shares is a way for companies to raise capital and may help them fund growth plans or be part of an exit strategy for the company’s founders and early investors. From an investor perspective, it’s often the first opportunity for the public to invest in the company.

It’s usually only the high-profile IPOs that garner media coverage, but IPOs are relatively common. According to consultancy firm EY, the London Stock Exchange had its strongest IPO performance in 14 years in the first quarter of 2021. In the main market, 12 IPOs raised £5.2 billion, while eight IPOs raised £441 million on the Alternative Investment Market (AIM). This compares to the £9.4 billion raised in the whole of 2020.

The UK is Europe’s leading location for fundraising, but it’s not just the IPOs on the London Stock Exchange that UK investors can invest in. Other stock exchanges, from the New York Stock Exchange to the Japan Exchange Group, can present opportunities as well.

While companies can follow a different IPO path and timescales vary, IPOs usually involve these steps, as set out by Morningstar.

Announcing an intention to “float”

“Floating” simply means that a company will issue regular shares to the public that are available to investors to trade. A company may have a large number of shares, but not all of these are floating stock.

For instance, an employee ownership programme may hold a large portion so they are not publicly available.

An intention to float is simply an official announcement of the company’s plans and may be used to create a buzz around the offer.

Publishing a prospectus

The company will then publish a prospectus, which sets out the company’s prospects to encourage investors to purchase shares.

It will usually include a description of the company, its strategy, historical financial information, risks, and information about management.

The Financial Conduct Authority (FCA) reviews the prospectus before the company can issue it to the public.

Setting a price range

For investors, the price range is important; it gives an indication of the company’s valuation and the cost of shares. The company will also state how many shares it will issue.

In the UK, a company floating on the London Stock Exchange must make at least 25% of their shares public. However, this isn’t an international rule and is currently under review.

Investment banks set the IPO process after valuing the business. They will look at a range of different areas, including industry comparables, consumer demand and growth prospects. As they consider demand, timing can have a significant impact on the share price.

In recent years, the tech sector has had some of the biggest IPOs. In 2020, tech and consumer interest accounted for 40% of IPO proceeds raised in London, a London Stock Exchange report showed. In the last five years, tech firms have raised £7.6 billion in London.

Conditional dealing

While shares are being bought at this stage, this isn’t the IPO. Only institutional investors can buy and sell for a set period, usually a few days.

The price of shares may rise or fall during this time.

After the period of conditional dealing passes, the shares are open for anyone to invest in; this stage is known as “unconditional dealing”.

What happens next?

Once the shares are live, investors can buy and sell stocks as they would any other investment. As a result, values can rise and fall.

In the future, a company can issue more stock if it needs a capital injection. This can reduce the value of existing shares for investors, but, on the flip side, it can also allow a company to drive growth projects that increase profitability.

Firms can also reduce the number of shares available by implementing a share buyback scheme.

Should you invest in an IPO?

While it can be tempting to invest in an IPO, it’s important to consider all the steps you normally would when making an investment decision. You should still consider how it fits into your risk profile and goals.

Aside from whether an investment opportunity is right for you, it often isn’t practical for retail investors to buy IPOs as soon as they’re available. This is for the simple reason that they usually aren’t that easy to buy.

Institutions, large banks, and financial service firms are given the first opportunity to invest. You’ll usually have to wait for them to start being traded to purchase shares.

However, your investments may still be exposed to IPOs. Your pension fund, as an institutional investor, for example, may purchase IPO shares.

Next steps

If you’d like to talk about your investments and what opportunities you have, please contact us.

We’ll help you build a portfolio that matches your goals.

Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.

The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.