There is nothing too difficult in understanding an Initial Public Offering of a company. A fairly formal process is undertaken, usually to offer to the public, via share purchase, the opportunity to own a part of a company. In the vast majority of cases, I.P.O’s are for the transition of a company from private ownership to public ownership.
Do your HOMEWORK! There are many reasons why public offerings are made, and it is the understanding of these reasons that is the key to making a successful selection. After meeting stringent but not foolproof regulatory guidelines, including professional valuations, an initial public offering can be made usually via a prospectus which will discuss things like the valuation, expected amount of capital raising, company performance history, management, owner’s ongoing interest, details of other potential major shareholders and RISK.
There is no investment without risk and prospectuses should outline a whole range of potential risks associated with the I.P.O.
The vast majority of initial public offerings are made to raise extra capital for the company. In many cases this capital will be applied to expansion plans, research, debt reduction and so on. This is not a problem in a well managed company but these are the areas where the risk can be high.
Often private companies have family management and the I.P.O. can be used to provide the capital to pay departing family for their share of the business. Once the company becomes public, some family members might be found inadequate in the eyes of shareholders and they can become obstructive, causing deep seated management issues. Rapid growth and change can also cause huge trading difficulties for previously small family companies.
If the capital raised is used primarily for debt reduction, you might consider why you would be choosing to be a banker for a company undergoing risky changes.
While there are plenty of examples of investors making huge profits by investing in I.P.O.’s, there will be enough examples of failure to convince most investors to exercise caution and due dilligence when assessing an investment in a previously little known company.
Sometimes, I.P.O.’s are made by large, listed companies in order to sell off a part of their business that is no longer core business for them. Use the same caution, they could after all, be just trimming what they percieve to be tomorrow’s dead wood.
Many of the most prudent and successful investors would recommend total avoidance of any initial public offering, preferring to adopt a wait and see approach. This can deny them windfall profits but it avoids the avalanche losses also.
Be careful, limit your exposure to a small proportion of your portfolio. Look past the hype, discover the facts, remember always that a mouthful can be hard to swallow. Cunning investors just nibble a little here and there while maintaining a high ability to move quickly if need be.