Initial Public Offering (IPO): meaning and how it works

Companies that meet certain requirements can be listed on the stock exchange. Being listed means they can obtain capital to reinvest in business development, accelerating the company's growth and expansion. The process of listing companies on the stock exchange is known as an IPO.

IPO stands for Initial Public Offering. It’s an initial offering open to investors who can buy the company's shares at a set price. For investors, IPOs can offer important investment opportunities, but as for all investments, you must assess these transactions very carefully.

An IPO allows investors to buy a part of the company so they can resell the shares on the market later should the price rise, or collect dividends.

The IPO process is quite complex, involving many professionals with specific skills. To be listed on a stock exchange, a company has to meet certain requirements and obtain authorisation from the authority of the country that oversees the proper functioning of that market.

An IPO is the offering of shares of a private company to the public through the creation of new securities that are then traded on the market for the first time. In other words, it’s the first issue of shares of a company that has decided to be listed on the stock exchange, after receiving the green light from the competent authority.

Investors can either buy the new shares and resell them immediately afterwards or hold them in their portfolio to make a long-term investment. In some cases, all investors can buy the shares, including retail investors; in other circumstances, only selected traders are allowed to take part.

Retail investors can often buy shares during a company's IPO through an intermediary, a broker or a bank that takes customer orders and executes them. The company's shares are first traded on the primary market, and after that can be traded on the secondary market, that is accessible to retail investors.

Before an IPO, companies are considered private as there are no shares that can be traded on the stock exchange. They are usually companies that have few investors. These might include founders, friends and relatives who have put money into the company, as well as professional investors such as angel investors and venture capitalists who invest in start-ups and small companies.

As a company grows, an IPO can become an attractive route to increase the number of investors and have more resources to grow faster. The capital obtained from the IPO can be used to develop new products and services, open new offices abroad or remunerate investors who believe in the company and want to monetise their investment.

When a company is listed on the stock exchange through an IPO, it becomes a public company to all intents and purposes, controlled by the majority shareholders who hold the largest shares in the company. The total of all issued shares represents the company’s market capitalisation, calculated by multiplying the value of an individual share by the number available to trade.

The share price for an initial public offering is set based on the valuation of the company and the number of shares to be issued. The market may consider this value to be excessive or low: in the first case, when trading in the new shares starts, the share price will tend to fall; in the second, it will tend to rise rapidly because many investors will buy the stock and will also be willing to pay more for it.

Investors can turn to an intermediary to invest in an IPO and buy the shares of the newly listed company. It is a risky transaction, as you are investing in a company that is entering the stock market for the first time. An investor, therefore, has little information about the company and, above all, it is not possible to apply technical analysis to study the performance of the shares.

In some cases, companies disappoint during the IPO by failing to live up to the initial valuation, while in other cases they surprise the market and the share price rises rapidly due to high demand. In any case, compared to an established company, IPOs carry more risk as the business has not yet been validated on the stock exchange and so may not be perceived as solid.

There is a strong speculative component in IPOs as the price tends to fluctuate a lot in the first weeks before stabilising when interest in the new company wanes. But IPOs can offer excellent investment opportunities to buy a company's shares while they are still new and before the price rises.

The most important thing is to study the company's business well before the IPO to grasp the real potential of its business and possible market sentiment. It is also necessary to define the right strategy for you; whether to speculate on the IPO shares in the short term or to buy them for a long-term investment if it’s a company you believe is on the path to success.