The term ‘IPO’ stands for ‘Initial Public Offering’. It indicates a company’s first offer to sell its shares to the public on the stock market. When the company comes to the stock market, this is known as ‘stock market flotation’, as it indicates the point at which the company is officially listed on the stock exchange. IPOs usually involve private companies. Anyone can buy the shares – from the general public, to other types of regular business investors. An IPO is essentially a chance to purchase new shares before they officially hit the stock market. Investors therefore see them as a good opportunity to purchase shares before competition heats up.

Companies have many reasons for deciding on stock market flotation, including raising money for accumulated debts, reducing shares in a company that one or more executives own, and improving the company’s reputation in the market. Investors decide to invest in IPOs as they are considered a good opportunity to buy shares at a reasonable price when a company is about to be listed on the stock market. IPOs can therefore be a good return on investment when usual trading begins and the price of the shares goes up to a higher cost. The flip-side however is that there is no guarantee that the value of the shares will rise. Investors should therefore carefully research the company they plan to invest in.

Companies tend to make announcements about their intension to be listed on the stock exchange. They will usually disclose information about how much money they want to raise overall, and who the biggest shareholders are within the company. Once IPO pricing has been determined at around 7am, it is likely that selling can begin at 8am the same day. Unconditional dealing (when the shares are available to the general public/whole market), typically occurs a few days later.

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Before investing in IPOs

Before investing in IPOs, it is important to research the company properly. Before listing on the stock exchange, a company needs to provide a prospectus that is available to all potential buyers. The prospectus should detail everything from the company’s forward strategy for the future, to its financial history, legal issues, accounting policies, taxation, and audited financial accounts. Before applying for shares, always read the company prospectus carefully so you can carefully gauge the level of risk you are taking on. Questions you should be asking include:

• Are the business owners selling the entirety of their stake in the business?

• Is there a strong indication of growth within this business and sector for the future? Can this be backed up with reasonable evidence?

• Will capital raised be used to pay off existing debts? Or to fund growth within the company?

Warning signs

You should be wary of investing in IPOs if the following applies:

• You have a suspicion that the company is overvaluing its shares. This is sometimes the case with IPOs, and can cause you to lose money overall if you jump in without properly researching the company and the reasons why it is selling.

• The track record of the company’s management is patchy, disorganised and its reputation within the sector it trades isn’t strong.

• Management have recently tried to leave and/or left the business.

• Suspicious acquisitions and trading relationships have recently taken place.

• The company isn’t in a competitive position within its market.

• The company is trying to raise funds on the stock market to counter under-investment.

Buying IPOs

When a company has decided to float on the stock market, the price of the IPO will either be restricted to just certain investors, or it will be available to the whole general public. Investors usually have up to a month (known as the offer period), to browse documentation and to conduct research into the company before placing an order. At this stage, the company will not have a fixed price, so you’ll need to carefully consider how much you want to invest. Most investors usually position themselves between the figures of £1,000 – £2,000. All investors will be required to confirm that they understand the risks in investing, and have considered the positives and negatives of IPOs carefully before taking the plunge. They will also need to agree that they have read the company’s associated prospectus.

When the offer period has closed, the official share price is usually made public within two days. If too many people have placed orders (and the IPO is oversubscribed), then you run the risk of not receiving the desired number of shares that you had hoped for. If the IPO is only open to institutional investors, you’ll only have access to it once it becomes available on the stock market.

Risks of IPOs

Investment isn’t without risk – here is what to look out for when dealing with IPOs.

• Some companies do not fully disclose all information in their prospectus or admission documents, leading to investors’ disappointment when they find out later down the line. For example, a company could have a number of legal cases in its background, or a poor financial history that it tried to cover up.

• New market entries can have elevated prices, so be wary and question whether share pricing is inflated.

• There is often little trading data upon which to base investment decisions when it comes to new companies entering the stock market for the first time. Don’t be persuaded by promises of large dividends alone.

• Those who expected a higher share valuation may decide to sell their shares in the new company immediately, which can have a knock-on effect on your investment and push share prices down even further.

If you need help or advice on investing in IPOs, Financial Advisor UK offers a network of FCA-approved financial advisors who are on hand to answer your questions and can help you diversify your investment portfolio.