After several years of growth a company decides it wants to expand. This could mean a new plant, store or buying another company. In order to do this it needs money (capital). The company enters into what is called the "primary market", this is where they meet with "investment bankers" who work for firms that specialize in raising capital (money) to help companies grow. The money might be either public (creating stocks or bonds open to the public) or private (getting individuals or groups to invest for a stake in the company, but the company remains private). Investment bankers review the company and its needs, and then suggest a course of action. If they decide the best course of action is to take the company public, they do this through a process called Initial Public Offering (IPO) of stock. When a person or company purchases stocks (see section on Stock Types Common & Preferred) they are purchasing a partial ownership of the company and have a claim on the corporation’s earnings and assets (such as a plant or office building, and everything in them).
Initial PublicOffering (IPO)
Investment bankers are hired by a company to raise money for the company so they can grow. They review the company’s background, financial conditions, earning history, competitors, management experience, current market environment and the economy. They talk to management to review their capital needs and growth plans. After their review, they might decide the best option to raise the necessary funds is by taking the company public. This is done by offering common stock in the company to the public, through a process called Initial Public Offering (IPO) .
Once a company decides to do an IPO, they must hire an investment banker to “underwrite” the issue, buying all the shares and then re-selling them at a pre-established price per share. Sometimes the investment banker has to partner with another firm, forming a syndicate, if the offering is a particularly large one. The primary investment banker is also known as “the lead underwriter”. But before the company’s shares are offered to the public they have to meet strict disclosure requirements set by the Securities and Exchange Commission (SEC), the government agency that monitors the stock exchange. In this disclosure all the important facts of the company have to be listed: plans about how the money is going to be used; officers in the corporation and most importantly risks investors might take if they purchase the stock. The information is printed in what is referred to as a “red herring” and when formalized, it is called a “Prospectus”. This must be provided to all potential buyers.
The investment banker, based on all their research of their client and market conditions, will establish an offering price for the new shares. They will also determine on which market the stock will be listed, which is primarily based on the company’s industry and size. These markets might include: The New York Stock Exchange (NYSE); The American Stock Exchange (AMEX); National Association of Security Dealers (NASDAQ) or Over-The-Counter (OTC) Stock Markets & Security Exchanges. Once accepted by the market, they will also be assigned a “ticker” or trading symbol by the listing exchange, for example: Apple (AAPL); Wal-Mart (WMT), Exxon Mobil (XOM). Finally, investment bankers are also responsible to promote and sell the IPO to the public.
If you want to purchase an IPO you should:
Read the Prospectus carefully.
Find out who is the lead underwriter since they are in charge of the distribution. If there are “syndicate members”, they also will have shares to sell.
If you do not have a brokerage account with one of the underwriters, you will need to open an account. You can try to deal with your broker, but chances are if it is a hot stock, you will not receive any of the initial shares. Even if you do have an account, you are not guaranteed to receive the stock at the opening price.
If you do receive an “allocation” of IPO shares you will be notified prior to the start of trading.
Take note that there can be a great deal of price instability in an IPO stock during the first few hours, days and weeks.