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What’s an initial public offering (IPO)?

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You may have been hearing about IPOs recently, or heard about companies “going public” or “going to market”.

They have been all the rage for the past few years so it’s very likely to have crossed your path, especially after the recent Wigton IPO which was heavily marketed (by the way, congrats to those who bought, as at the end of June it’s risen 76 per cent in value).

A beginner, however, may feel overwhelmed or lost regardless of the recent popularity, so let’s get into breaking it down.

As always, I give the simplified version of these things.

When a company wants to expand hugely and quickly, they have one option, get more money. This money can pay for more employees, buy machinery, upgrade a fleet, whatever. You already know all the things money can do. There are only two ways to get this money however:

1. Get a loan.

2. Sell a piece of itself to someone to raise the money.

Both of these options are viable for companies, but they come with their own set of rules. In Jamaica, to get a bank loan as a company you have to jump through quite a few hoops. The comedian Bob Hope once said, “A bank is a place that will lend you money if you can prove you don’t need it”. Many a small business owner might agree with this.

In addition to jumping through the hoops and after actually getting the loan, the bank usually has ‘healthy’ interest rates attached to the payback. When you’re running a business on an 18 per cent profit margin, a 15 per cent loan might seem like death. Fret not, there is another way as I said before, and an IPO is something that’s related to the second option.

THE SECOND OPTION

This option is where the magic happens. The company can sell a piece of itself to someone so that a person (or persons) become part-owner(s) of the company.

The money they get from that sale can then be used for whatever they may wish. This of course means that they don’t have to jump through the same hoops that the banks may impose and, even better, they don’t have to pay the money back and will thus avoid having to pay interest.

This is the crowdfunding route which, instead of making you answerable to one individual for a large amount, makes you answerable to many people for small amounts. It’s similar to the method former US President Barack Obama used to fund his first campaign.

Now, don’t think this means that you’re getting away scot-free because you’re a company who takes on investors. Going this route means that while you avoid the bank’s hoops, you’re now answerable to these new people who are part-owners and get a say in the running of the company. So that’s the trade-off, give up a piece of your company, and get the money without bank hoops and interest, or get through the bank’s red tape and pay back with interest…if you get the loan in the first place.

Now, a company can do either of these two things without “going public”. You can invite just your small group of friends/family to buy into your company, and if they have the money and you guys have an agreement, then great, you’ve taken on new investors. However, “going public” is a specific thing.

“Going public” is another term for having an IPO (IPO, by the way, means “initial public offering”).

Going public, or having an IPO means that a company has decided to offer a piece of itself to the general public and be listed on the stock exchange, and anyone (yes, including you) can buy in.

Now, whenever a company decides to list itself publicly it does have to follow certain rules. Unlike the hoops of the banks, however, these rules are meant to keep the general investing public (again, including you) safe. These rules outline the things that companies that want to list have to do.

They cover basically two things.

THING 1

These rules tell a company how to and how often to report on what’s happening inside the company, and what things have to be in those reports; how much money they got —revenue; how much of that they got to keep — profit; what they spent the rest of the money on — expenses, among other requirements.

These rules have to be adhered to in order to remain a listed company and continue receiving the benefits of being listed. This allows you, as a new part-owner (shareholder), to know how your company is doing after it lists. It also allows prospective owners to know if they want to join in and buy shares in a company, as they usually include the prior year’s financial performance and/or financial projections.

THING 2

The rules tell a company how it has to approach everyone initially if it wants to become a listed company.

Key in that approach is a document called a prospectus, which is made available to everyone. This is like the resumé of a company. It’s pretty detailed because it’s a legal document which has to tell you lots of things about the company.

Think of it like a document you would want to get on a potential boyfriend or girlfriend. It’s them telling you who they are, what they do to make money, how much of themselves they’re offering for sale (admittedly not an attractive quality in a boyfriend/girlfriend), what price they want for that portion of the company, how much they think that is worth, how they plan to spend the money you’re gonna give them for that etc.

In addition to all of this the prospectus tells you when they plan to start and stop taking offers (opening and closing date); who is the lead broker taking them to market; and the steps to follow if you want to buy a portion, which is usually outlined in a form in the prospectus to be filled out by prospective buyers (this means you).

Conclusion

So, let’s summarise it all. An IPO (initial public offering, listing, going public) is when a company decides to list itself on the stock exchange. This is usually followed by a prospectus, which tells the details of the company, the details of the offer, and how to participate in it.

Simple, right?

Now that you know what an IPO is, get ready to participate in a few, because if the company is good, they are usually very profitable in the long term for those who do.

There is one more term that you are likely to hear a lot about with regards to IPOs, that is “oversubscribed”.

This means exactly what you think it does. A company asks for X million, but the offer is so attractive that they get XXX million in response. When this happens the broker usually divides up the portion that is on offer to the public in a fashion that allows everyone to get a share. Sometimes it’s not a very big portion if the offer is very popular, which usually leads to having to buy more shares in the company after it lists in order to get the full amount you wanted.

Hope this was clear and helped everyone to understand what an IPO is. If it wasn’t, let me hear your complaints on Twitter (@RTRowe) and if it was, you can tell me at the very same place and also share this article with a friend who may want to know.

Until next time!

Randy T. Rowe is a corporate strategy consultant and self-taught investor. You can find him on Twitter @RTRowe and on his personal finance website www.everymickle.com. He was very excited when Sweet River Abattoir (SRA) had their IPO because then he could say that “Those little piggies went to market…” Their company results since then have been very poor so his excitement about that has been cut short…much like the lifespan of piggies they see every day.

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Source: Initial Public Offering Search Results
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