How IPOs work and what to know before investing

An IPO, or initial public offering, is a major milestone for a company. This marks the point at which a private company becomes a public one, as it sells shares of the business on a stock exchange for the first time. But what exactly does it mean for investors?

Most obviously, an IPO marks an initial opportunity for the general public to invest. When big-name, big-hype companies like Anthropic, the maker of the Claude chatbot, or the Elon Musk-backed SpaceX, are the ones going public, it may seem like an exciting opportunity — but that still doesn’t mean it’s a sure-fire investment.

What is an IPO?

It is the “event in which a private company converts to a public company by offering for sale a portion of its ownership through newly issued shares, enabling public investors to purchase equity and allowing its stock to trade on a public exchange,” said Investopedia. Where private companies are owned by only their investors and founders, public companies are also owned, in part, by the investing public. Public companies are beholden to Securities and Exchange Commission (SEC) requirements and must file regular financial reports.

For an IPO to happen, a company does not just flip a switch. The process of going public typically entails hiring investment bankers to underwrite the deal and help with determining valuation, followed by a large amount of legwork, including undergoing audits, preparing regulatory filings and drumming up investor interest.

Why do companies go public?

There are a number of reasons. A major one is funding, with many companies issuing an IPO to raise money on a larger scale, perhaps to pay off debts or fund further growth. Once a company goes public, it can also issue more shares, which can help with future efforts to raise capital. A company may additionally want to “raise their public profile or to allow company insiders to diversify their holdings or create liquidity by selling all or a portion of their private shares as part of the IPO,” said Fidelity.

Is an IPO a good investment opportunity?

While “prospective shareholders may view the IPO calendar as a chance to invest early in a company’s public-market journey,” said U.S. Bank, “positive media coverage alone does not make an IPO an appropriate investment.” As such, it is important that investors do their homework before buying.

The main place to look is a company’s prospectus, as companies that were private until recently will have limited public information available. This document, which the lead underwriter and issuer will provide, will include “information on the company’s management team, target market, competitive landscape, who is selling shares in the offering, who currently owns shares, expected price range, potential risks and the number of shares to be issued,” said Fidelity.

Beyond that, it’s important to have a handle on your expectations. “Share prices can rise or fall quickly once trading begins,” and even “well-known companies can still struggle after going public,” said TD. There is also the chance you will not be able to buy all of the shares you want to, given that “popular IPOs can be oversubscribed, meaning demand may exceed supply.”