One of the first questions new investors seem to want to ask is whether or not they should be looking at investing in initial public offerings, or IPOs, for their portfolio. An IPO, in case you haven't learned about the specifics, yet, occurs when a formerly private business decides to take on outside investors, either by having the founders sell some of their shares or by issuing new shares to raise money for expansion, while, at the same time, listing those shares on a stock exchange or an over-the-counter market. With the initial public offering (IPO) market the strongest it’s been since 2007, according to data provided by Thomson Reuters, and e-commerce giant Alibaba’s record-setting IPO still attracting attention, many average investors are picking up on these new-to-market, buzzworthy securities and wondering if they can (and should) get into the action.
Consider The Coca-Cola Company. A single share of Coke purchased for $40 in the IPO back in 1919 would have grown to more than $5,000,000 with dividends reinvested by the time this article was originally published on July 31st, 2006. Now its the figure stands at more than $15,000,000. The Coke IPO changed lives forever. (One small town, Quincy, Florida, became the per capita millionaire record holder in the United States because the local banker convinced everyone the company was one of the greatest businesses in operation. The banker realized that not only were the financial statements strong, but that the product was largely insulated from economic stress such as recessions and depressions because even if you lost your house, your job, and were waiting in a breadline, if you came across a nickel, you might spend it on a glass of Coca-Cola; an affordable luxury that provided momentary pleasure.
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The main advantages of IPO investing are listed below.
1. Access to capital to fund growth
Public placement of shares on a stock exchange allows the company to attract capital to fund both organic growth (modernization and upgrade of production facilities, implementation of capital-intensive projects) and acquisitive expansion.
2. Creation of liquidity and potential exit for the current owners
Formation of a public market for the company’s shares at fair price creates liquidity and provides an opportunity to sell the shares promptly with minimal transactional costs. The private owners of the company can dispose of their stakes in the business both during an IPO (this route is often taken by the minority financial investors such as venture or private capital funds) and at a later stage (this is often preferred by the majority shareholders).
3. Maximum value of the company
Normally, an IPO is an offer to a large number of institutional and retail investors to become shareholders of the company. The very multitude of large investors and their confidence in the liquidity of their investment in a public entity assure the current owners of a private company about achieving the maximum possible valuation of the business at the time of an IPO or afterwards.
4. Enhancement of the company’s public profile
Listing on a recognised stock exchange means that the business will receive wide media coverage, usually a very favourable one, thus increasing the company’s visibility and recognition of its products and services. The company’s activities will also be reflected in the reports by professional financial analysts.
5. Improvement in debt finance terms
For domestic financial institutions – used to working with the low-transparency businesses and often inadequate financial reporting – a company listed on a recognised stock exchange becomes a desirable and reliable partner. Banks are often ready to extend loans to public companies in larger amounts, under smaller collateral, for longer maturities and with lower interest rates.
6. Extra assurances for partners, suppliers and clients
Partners and contractors of a public company feel more confident about its financial state and organizational capabilities as compared to those of a non-transparent private business. Partners take additional comfort in the fact that the public company has gone through rigorous legal, financial and corporate due diligences – all of which are required for a successful completion of an IPO.
7. Enhanced loyalty of key personnel
Publicly available information about the share price of a public company allows development of employee motivation schemes based on partial remuneration of staff in the form of participation in the equity capital (for example, share options). Equity-based incentive schemes stimulate the key personnel to become more efficient in their work in order to support the company’s growth rates and profitable development – which in turn increase the operational and financial efficiency of the company and its market value.
8. Superior efficiency of the business
Conduct of various due diligences during the IPO process requires a thorough and comprehensive analysis of the company’s business model. During the IPO implementation process, certain internal changes take place, including modification of the organisational structure; selection of the key personnel and delegation of responsibilities; improvement of internal reporting and controls; as well as critical evaluation of the efficiency of the entire business.
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