Facebook's much-anticipated IPO --which stands for initial public offering-- is a market event destined for the history books. Investor interest is at fever pitch, drawing attention from major Wall Street institutions, to individual investors on Main Street, and even people who may have never bought a stock before.
And so for that reason alone, that our next installment of "Investing 101" will tackle the ins & outs of the IPO market. With the help of acclaimed editor of IPODesktop.com Francis Gaskins, we put together a list of 5 common questions and answers about the IPO market.
1) What Exactly Is An IPO?
As the name implies, it is a stock sale that allows the public to buy shares of a company listed or traded on an exchange, usually for the first time ever. As Gaskins points out in the attached video, these may be new stocks, but they are not necessarily new companies. To use the Facebook example, the website and business has been up and running since 2004. And in rarer instances, a company like General Motors (GM) can move in and out of being a "public" company. GM reissued an IPO in November 2010 after reemerging from bankruptcy and unwinding its majority government control.
2) Why Do Companies "Go Public" --Issue IPOs?
The reasons vary, but the most common objective is to raise money, Gaskins says, which can be used for any number of things, including paying off debt or the owners of the business. Other uses of the proceeds from IPO's include expanding the business, acquiring a rival company or simply to create liquidity, which makes it easier to buy or sell your company's stock. Again, to use Facebook as an example, their IPO is partly due to federal law requiring businesses that have more than 500 investors and $10 million in assets to list their shares.
3) How Do You Buy Into An IPO?
Once you have done your research and made up your mind, the most basic step, Gaskins says is to have a brokerage account so you can put in an "indication of interest" or I-O-I, that you would like to buy shares in a particular deal.
In fact, the bigger the offering and the more buzz there is around a particular company, the lower the chances are that you will be able to get any stock at the offering price, which means you would have to buy it in the open market, frequently at a higher price, after it has started trading. As a general rule, if you are a small investor and able to actually get shares in an IPO, you probably should walk away from a deal that is likely to trade lower.
4) Are IPOs Off-Limits To Small Investors?
Not necessarily. While I wish I could tell you that it's a ''level playing field'' out there when it comes to IPO's, it just isn't. Typically, the first investors allowed in on an IPO are company executives, venture capitalists, and the banks involved in underwriting the deal.
But look on the bright side, if you miss out on a hot deal, chances are good that you might get a chance to buy it even cheaper if you wait a while. What happens after a company's first hour/week/month of trading is often a completely different experience than what goes down in a particular stock's first few manic moments of publicly traded life.
As Gaskins discovered, out of a dozen internet/social media IPO's that came public in 2011, the average decline was 12% from the IPO price, and a 34% drop from where the shares closed the first day's trading.
5) Are "Hot" IPOs An Easy Way To Make Money?
Like any investing, Gaskins points out, there are risks and rewards involved whether you are buying an IPO or shares of an established stock like AT&T (T). Generally speaking, those 20 or 30 or 50 percent first day gains that you may have read about are not only rare, but all of the shares are typically spoken for and allocated to the biggest and best clients of the investment banks that are underwriting the deal.