Many people are interested in passive income, when they have “extra” money. Some people prefer to put money in a bank. This is not very profitable, since most banks offer fairly low interests. An alternative way to get funds to work is long-term investments in stocks through the stock exchange. For example, people buy the assets of large companies and expect that they will rise in price over time. Another option is to invest in an IPO.
What is IPO and How Does It Work?
IPO means an initial public offering. A legal entity launches an IPO on a stock exchange to attract outside investors. IPO gives the company an opportunity to attract additional funds to the budget in exchange for a share in the company.
To understand what are the pros and cons of an IPO for an investor, let’s look at the procedure for the initial issue of shares first. Usually it includes four stages:
· Attracting banks, the so-called underwriters, which invest their own funds in stocks before the issue and will search for the largest third-party investors.
· Preparing an official prospectus, a document that indicates all the basic information about the company, according to which future investors will be able to assess investment risks, as well as financial statements. The finished prospectus is submitted to the Securities Commission.
· Searching for the largest and most influential investors, including through the distribution of promotional materials and personal meetings with company representatives along with the collection of applications for the required number and possible value of stocks. This process is also called a road show and usually takes about 2-3 weeks.
· The procedure ends when the stocks, which have a price and total volume, are listed on a stock exchange and investors can apply to acquire them.
PROS AND CONS FOR INVESTORS
There are several significant advantages for investors, participating in IPO:
· Opportunity to receive shares at a special, low price, available only to the first investors who decided to purchase stocks of the company before its actual entry into the stock exchange.
· Prospects for profit growth, since the price can significantly increase in the first hours of trading on the exchange.
At the same time, an IPO is not a completely reliable option, since there are certain restrictions and risks for investors:
· Before an initial public offering, a company cannot disclose the exact price of stocks, only an approximate range.
· Not all IPOs are profitable.
· In case of high demand, the company may experience problems with the full execution of IPO applications, that is, instead of the requested amount of securities, an investor may be provided with a smaller amount.
· Stocks have a lock-up period – the period immediately after the company goes public, during which the purchased stocks cannot be sold. At Just2Trade, the lock-up period is 31 days.
HOW TO INVEST IN IPO?
Since individuals cannot gain access to an IPO without a broker, participation in an IPO looks like an ordinary investment in exchange-traded assets for them.
Standard plan is as follows:
1. Choose a broker offering IPO access. Not all brokerage companies have this opportunity. Basically, it can be found in the list of services of large brokers with access to world exchanges.
2. Open and fund an account with a selected broker.
3. Select a specific company to participate in the IPO.
4. Apply through a broker.
RECOMMENDATIONS FOR INVESTMENT PORTFOLIO
Despite the fact that investment in IPOs can give a rapid increase in profits, it can be considered exclusively in the long term, since there is a lock-up period. So, it is better to investing only a part of the available funds. The remaining funds can be invested in “ordinary” securities or other assets through the same broker. This diversification will reduce risk exposure and mitigate possible losses with the help of other types of investments.