What is an IPO (initial public offering)?
Invest inWhen you follow financial news, you regularly come across the term ‘IPO’. An IPO is a way for a company to raise money from the general public to realise its ambitions. But what exactly happens behind the scenes? And what does an IPO mean for you as an investor? Read on, because after this article you will understand not only the definition, but also the process, the advantages and disadvantages, and how you can invest in IPOs at BUX.
What does IPO mean?
An IPO (Initial Public Offering) is a stock market flotation where a company offers stocks to the public for the first time, so that investors can buy and trade them on a stock exchange. The stocks are therefore no longer only in the hands of the founders, management, early investors, or private parties. In British English, an IPO is also referred to as a ‘flotation’ or ‘going public’.
Good to know: IPO is also the abbreviation for ‘Interprovinciaal Overleg’, which represents the interests of the twelve Dutch provinces in The Hague and Brussels. We will disregard this meaning further.
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Why do companies want to go public?
A company usually wants to go public to raise capital from a wide group of investors. For example, to be able to innovate or to finance a new product. The company does not have to arrange financing through the bank or private investors but can do this via the capital market. This can accelerate growth plans.
Additionally, brand awareness can be a reason to go public. It can provide a good reputation, credibility, and trust because there are many rules associated with a flotation.
The advantages of an Initial Public Offering
An Initial Public Offering can be a smart step for a company that wants to grow larger. It offers various advantages, as you can see in the table below.
Advantage
Impact on the company
Raising capital
A successful IPO can raise more money for expansion, research, development, and paying off debt than through a few investors.
Less dependent
The company is less dependent on a handful of investors. What if one of them suddenly passes away or goes bankrupt?
Means of payment
The company can use its own stocks as ‘currency’ to acquire other companies. This makes acquisitions easier and less burdensome on cash reserves.
Liquidity for investors and founders
Owners and early investors can use an IPO as an ‘exit strategy’. They cash in (part of) their stocks by selling them after the company has gone public.
Public image and brand awareness
A flotation can provide more credibility because the company must comply with strict rules. It can also create brand awareness through media attention.
Attracting and retaining talent
A listed company can attract new talent or retain employees with stocks, thus linking them to the success of the business.
Legitimacy
A listed company is seen as legitimate because it must make its accounts public. This can make financing cheaper and easier.
The disadvantages of an Initial Public Offering
Although an Initial Public Offering offers companies various advantages, there are also a number of points of attention to consider.
The disadvantages of an IPO
Disadvantage
Impact on the company
High costs
An IPO involves high costs. Think of fees for lawyers, investment bankers, accountants, and external consultants. Companies also pay four to seven per cent of the raised capital to the bank (underwriter).
Financial reporting
When a company goes public, it gains ongoing obligations. Think of financial reports, updates, and transparency towards the market. This can turn out to be complex, time-consuming, and expensive.
Pressure to perform
Pressure arises to show growing profit figures. This can come at the expense of long-term investments.
Regulation
After a flotation, the company falls under strict supervision. Complying with all laws and regulations is time-consuming, and errors can lead to fines.
What is the process of an IPO?
The IPO process is the trajectory in which a company prepares to realise a stock market listing: from valuation and prospectus to pricing, allocation of stocks, and the first trading day. This process can be divided into seven parts:
1. The decision to go public
The IPO process starts when the company wants to make stocks public on the stock exchange. Important stakeholders first decide whether an IPO fits the development and plans of the company.
2. Choosing underwriters
During preparation, one or more investment banks are chosen to advise, guide, and organise the issuance. These banks are also called ‘underwriters’ and play a major role during an IPO. In fact, they help prevent the flotation from failing completely. Accountants and lawyers are also brought in to audit the financial administration and legal structure.
3. Prospectus
The company puts legal and financial data in order and ensures compliance with regulations. A prospectus is also drawn up containing information about the company, the financial situation, risks, and future plans.
4. Filing with the regulator
The company submits documents to the regulator and shows that it meets rules and transparency requirements. In the Netherlands, the AFM (Authority for the Financial Markets) must approve the prospectus, with or without any amendments.
5. The marketing roadshow
The company’s management presents growth potential and financial outlooks to large institutional investors, such as pension funds and banks, during a so-called ‘marketing roadshow’. They visit them to show why it is worth investing in the company.
6. The introductory price is set
These investors indicate how many stocks they want to buy and at what price. The introductory price is then determined by the bank, based on valuation and demand. After that, the stocks are distributed among the investors.
7. The first trading day
The stocks enter the market during the first trading day, such as Euronext or Nasdaq, and investors can buy and sell them.
The largest shareholders, often the founders and management, sign a lock-up agreement. During this lock-up period, they are not allowed to sell their stocks for 90 to 180 days. This helps ensure stability around the flotation so the price does not immediately fly in all directions.
How long does the IPO process take?
There is no fixed timeline for an IPO process, as the duration depends on how well the trajectory is managed and coordinated. Financial management, market conditions, and the complexity of the company also play a role in the duration. Companies often need a long preparation time for a flotation (IPO), which can vary from 6, 12, 18 to sometimes 24 months or longer.
What does a flotation cost?
The costs of a flotation also depend on the size of the IPO, but you can assume it is expensive. The largest cost items are the underwriter(s), listing fees, legal advisors, accountants, and audits. Roadshows and insurance also involve costs, as do the registration requirements of the exchange on which the company is listed. This can total hundreds of thousands to millions of euros.
The conditions for a flotation on Euronext Amsterdam
On Euronext Amsterdam, a company must meet a number of conditions to be listed, according to Ondernemersplein. Namely:
- The company has existed for five years or longer.
- The company must have made a profit in at least three of the past five years.
- Equity is at least five million euros.
- The stocks being issued are worth more than five million euros.
For some companies, the above requirements may be too high. Therefore, the Nederlandsche Participatie Exchange (NPEX) also exists. This is an exchange for small and medium-sized enterprises (SMEs) that sets lower requirements, such as one year of profit.
Is buying an IPO a good or a bad thing?
Investing in IPOs, like any form of investing, involves risks. The price is an estimate and may turn out higher or lower than the estimated price on the first trading day. That is also why some investors choose to first see what the share price does before they buy stocks.
It is advisable to see if an IPO fits into your investment plan. It can also be a good idea to research the financial health of the company and read the prospectus.
IPOs for retail investors at BUX
Do you want to invest in IPOs? You can at BUX. We are the only broker in the Netherlands that offers some IPOs to retail investors.
You will receive an email when there is an upcoming IPO. Are you interested? Then you will be redirected to a special form. Fill in your personal details and the amount you want to invest. Do you qualify? Then we will invite you to participate.
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Investing involves risks. You can lose your investment.
All views, opinions, and analyses in this article should not be interpreted as personal investment advice. Individual investors should make their own decisions or seek independent advice. This article has been prepared with a view to providing information and should be considered marketing communication.
