What is an IPO?
An “IPO” or “initial public offering” is the first sale of stock by a private company to the public. IPOs are often issued by smaller, younger companies seeking the capital to expand, but can also be done by large privately owned companies looking to become publicly traded.
An example if the recent offering to the public of the common stock of Facebook. This company was private until it decided to offer it shares to the general public and allow itself to be traded on a major exchange. From Investopedia.
In an IPO, the issuer obtains the assistance of an underwriting firm, which helps it determine what type of security to issue (common or preferred), the best offering price and the time to bring it to market.
The benefit to the founders of the company is that it gives them the ability to sell part of their stake in the company to the public, often making them millionaires or even billionaires overnight. It also provides the company with much more capital than it previously had for purposes of expansion and growth.
The benefit to the public is their ability to participate in the company’s growth alongside the founding shareholders.
IPOs should be viewed with a great deal of caution.
IPOs can be a risky investment. For the individual investor, it is tough to predict what the stock will do on its initial day of trading and in the near future because there is often little historical data with which to analyze the company. Also, most IPOs are of companies going through a transitory growth period, which are subject to additional uncertainty regarding their future values.
Investors in the IPO of Facebook found this out when the excitement and hype surrounding its initial offering resulted in such a demand for the stock that people were willing to pay much more for the stock than was warranted.