An initial public offering – or IPO – is the process by which a private company becomes publicly traded by listing its shares on a stock exchange, with the help of an underwriter or investment bank. This is also known as “floating” or “going public.”

Companies go public for many reasons – it could be to raise funds from public investors or to provide liquidity to existing shareholders. Funds may be used to support growth, buy other companies or reduce debt. 

IPOs could eventually provide an “exit” path for founders, employees and early investors to cash out their investment.

Not just any company can IPO. To go public, companies have to meet a range of requirements established by securities regulators and the exchange in which the shares will trade.  

Requirements may include: a minimum number of years in operation, audited financial statements, and a certain level of pre-tax income. Exchanges – even in the same jurisdiction – can have different criteria. Becoming a publicly-traded company typically involves significant upfront and ongoing expenses, therefore companies are often relatively large before undergoing an IPO.

The IPO process is a lengthy one with a whole host of people involved.

Investment banks act as “underwriters” which means they manage a significant portion of the IPO process, including due diligence, document preparation, regulatory filings, investor marketing and share issuance. They serve as a link between the company issuing the shares and investors.  

The underwriting bank will appoint a “lead underwriter”, whose role is to gather feedback on the company and its value from institutional investors. This feedback informs the number of shares issued as well as the issue price, which is typically set as a range during the final marketing phase.

The most common type of underwriting is “firm commitment”, where the investment bank buys the company’s new shares at a specified price and then sells them on to the public. This ensures a certain share price for the company and the bank will typically earn a spread on the price. 

Alternatively, underwriting can also be done on a “best-effort” basis, where the underwriter doesn’t buy the shares itself but acts as an agent to sell as many as it can. 

The majority of IPO shares are issued to institutional investors and large investors. However, individual investors can also access IPOs through their broker. To participate in an IPO, you need to have an account with a broker offering access to the listing. 

Make sure you research the offer thoroughly by reading its prospectus and check if there are any eligibility requirements. 

Next, you submit an ‘indication of interest’ specifying the number of shares you want to purchase. 

Once the offer period closes, your broker lets you know whether or not your application is successful.  

Investors aren’t guaranteed to receive all or even any of the shares they want. If there is a lot of excitement around a company, the IPO may be oversubscribed. 

There’s more than one way to become a public company, and direct listings are an IPO alternative that is occasionally utilized by companies who wish to become publicly traded. 

The main differences are there’s no underwriter involved (making the process cheaper) and the company doesn’t create any new shares – it just lists existing ones. 

Companies that go public via direct listing are generally not trying to raise new capital. Instead they are typically seeking the other benefits of public listing, like higher liquidity and allowing stakeholders to cash out. 

Companies with a strong consumer brand and a simple business model are more likely to have a successful direct listing – retail investors are more inclined to back companies they know and understand.   

Direct listings are more time and cost effective, but they come with more risk. Without an underwriter, the listing company has less certainty of interest in its shares – and potential investors need to do their own research. After listing, the shares are typically more volatile than after an IPO – that’s because the price is set without input from institutional investors.

Taking part in a direct listing is more straightforward than an IPO, - it’s the same as buying shares already listed on the stock market via your broker. 

First of all, share prices can fluctuate extensively in the aftermath of both an IPO and a direct listing. Companies can experience significant hype before going public, but a share may end up settling below its initial offering price when the excitement recedes.  

In the case of IPOs, if the intermediaries set the offering price too high, it can drop once the shares start trading. 

Although every company has to publish a prospectus before floating or going public, investors may only have access to a limited amount of information if the company is young. This can hamper your ability to make an informed investment decision.