What is an IPO and does it bring profit to the investor

An IPO allows you to become the first investor in a company by getting a stake in it before anyone else. But sometimes thoughtless participation in it can turn out to be a loss of money. In this article we tell you how to take part in a successful IPO and what risks there are for an investor.

IPO – procedure of initial public offering of shares, which allows the company to go public

Any business, even the most successful, needs investment. Money may be needed for development and scaling, upgrading logistics, servicing loans, and many other purposes. In most cases, the solution is a loan from a bank. Sometimes young companies find business angels — investors willing to invest in a startup in exchange for a share in it.

Another way of obtaining money for business development is the stock exchange. Here a company can either issue its own bonds, having determined the parameters of borrowing that are comfortable for itself, or hold an IPO, placing part of its shares. The latter method of entering the trading floors is more popular.

IPO and other share placement options

Initial Public Offering, or IPO — initial public offering of shares. The company’s securities are sold to an unlimited number of investors who, after the IPO, start trading with each other. With the help of this procedure, business owners can find out the market value of the company and, most importantly, raise money for its development.

Primary public offering of shares not only allows the business to address its own objectives but also imposes certain obligations on it. For example, after an IPO, the company is required to disclose quarterly and annual financial statements. The regulations for such disclosure are determined based on the rules of the trading platforms.

Usually, investors show a high interest in the initial public offering of stocks on the stock exchange because they hope for their further growth. However, in practice, such growth can be speculative, and after some time after the IPO, the company’s value turns out to be significantly lower than in the first trading days.

The main stage involves collecting bids to purchase the company’s shares. It may determine the value of securities, if it was not set in advance. Depending on the volume of bids, the allocation – the percentage of satisfied bids – is determined.

For example, an investor left an application for participation in an IPO in the amount of 20,000 roubles, and the allocation was determined at 40%. Accordingly, the investor will receive securities worth 8,000 roubles and 12,000 roubles less commission will be returned to the brokerage account.

The final stage will be the beginning of securities circulation on the exchange, called listing.

How to participate in an IPO for a private investor

The ability to purchase shares in an initial public offering depends on two criteria:

  • investor status;
    platforms for participation in the placement.

IPOs on foreign stock exchanges require qualified investor status. Such IPOs are accompanied by a high entry threshold, for example, from USD 10,000. Given that such shares are subject to high volatility in the first days of trading on the stock exchange, such an investment is an unjustified risk.

Many illegal intermediaries have been set up to circumvent such strict conditions, including for persons who do not have the status of “Qualified Investor”. Investors trade with the intermediary’s funds, which are fully secured by collateral. If the investor loses money, the collateral is written off. This opens up a field for fraud, the Central Bank of the Russian Federation is fighting such intermediaries, and we do not recommend this scheme of work.

In order to participate in an IPO, one must meet the requirements regarding investor status and payment amount

The terms of participation in an IPO on the Moscow Exchange are determined by the issuer and your broker. The latter sets the minimum amount of participation in trading, the amount of the participation fee, and the deadlines for accepting applications. Most initial public offerings on the Russian stock market do not require “Qualified Investor” status.

Examples of successful IPOs and possible risks

The success of an IPO depends on the timing of the IPO. If it is a “bullish”, growing market and the financial system is benefiting from the soft monetary policy of the world’s central banks, the IPO should be a success.

For example, in November 2020, the IPO of the Airbnb accommodation service took place. On the first day of trading on the trading floor, the value of shares rose by 112%, and capitalization exceeded $100 billion.

History knows a lot of examples of failed IPOs, so novice investors are better to look at classic investment instruments

The largest in terms of funds raised was the IPO of oil giant Saudi Aramco, which managed to raise $29.4 billion in 2019. Other leaders include:

  • Alibaba Group – managed to raise $25 billion in 2014;
    Facebook (activity on the territory of Russia is prohibited) — in 2012 IPO brought the owners 18.4 billion dollars;
    Visa — in 2008 it raised $19.7 billion.

However, IPOs should not be regarded as a mechanism that works flawlessly in favor of companies. There are often situations when some time after the initial public offering the capitalization of the company decreases. Ozon shares in the first weeks after the IPO (November-December 2020) reached 5,000 rubles per unit, and as of November 2021, the retailer’s share is worth just over 3,000 rubles. Shares of Uber Technologies Inc. which owns a well-known cab brand collapsed by 7.6% on the first day of trading on the stock exchange.