IPOs explained

How companies float on the stock market

Ever read about a household name floating on the stock market and wondered if you should invest?

There can be plenty of buzz when a well-known company announces plans to float on the stock market. There were 86 flotations on the London stock markets between January and early December 2015 1.

A flotation is also known as an Initial Public Offering (IPO) or a new issue. It marks the first time a company sells shares to the public. An IPO may occur because smaller companies are looking to raise money to expand. Larger companies may also be seeking to increase the number of shareholders, raise funds to make acquisitions, restructure their finances or raise capital.

Sometimes, however, the reason for the stock market flotation is because existing investors are seeking to sell their stakes in a private company. Or the government wants to raise money by selling shares in large national companies. Examples include British Telecom and British Gas in the 1980s.

Government share sales often attract a great deal of interest from investors, including those who may not have much experience of investing in the stock market. This is because the companies tend to be large, well-known names and members of the public are invited to invest as well as financial institutions like pension funds. With the Royal Mail IPO of 2013, almost a fifth of the shares were offered to private investors 2.

 

In some cases, the government has offered incentives to encourage people to invest. In 1984, for example, the privatisation of British Telecom enticed over two million people thanks to discounts on the market price 3.

 

These sales often generate widespread excitement, but this doesn’t mean you should get carried away with the furore and buy shares yourself. It is crucial to recognise that all shares can fall in value as well as rise. Investors in government share sales, just like any other IPO, risk losing some or all of their money if the company performs badly in the future. Therefore, as with any other investment, you should only put money in if it fits in with your financial goals and you fully understand the risks.

How IPOs work

An IPO enables a company to become publicly listed on a recognised stock exchange, such as the London Stock Exchange (LSE). IPOs, including government share sales, usually work like this:

First, the company announces its intention to float (ITF). It’s a formal announcement to a stock exchange such as the LSE. The ITF announcement typically includes the company’s investment highlights and details of who can invest i.e. retail investors or institutions, and sets out basic details of the IPO.

When the IPO is launched, the company will publish a prospectus, pricing notification and other supplementary documents. This will detail comprehensive information about its business and plans for the future, including risks that might affect the company. It also produces a guide price range, giving an indication of what it thinks the shares will cost. This isn’t guaranteed; the final price might be higher or lower. At this stage, investors can apply for shares in the IPO through an approved intermediary participating in the offer.

Once the offer period ends – it may close early if demand is high – the company announces the price of the shares and notifies investors of the allocation they have received. If demand exceeds supply, investors may not get all the shares they applied for. In that case, the company will show how it is scaling back allocations.

Finally, the company begins trading on the stock market, with investors able to buy and sell shares freely. It will trade like an ordinary share with a buy/sell price being made available, however the price of the shares will rise or fall depending on demand and supply. There may be a period of conditional dealing which typically lasts for 3 days and is linked to the IPO deal settling on the stock market. At this time, purchases in an ISA are not permitted.

What to look out for

Investors tempted by an IPO will need to think hard about why the company is floating on the stock market. They’ll also need to know what it plans to do with the money raised and whether it has the potential to succeed in its field. You’ll be able to form views by reading the company’s prospectus, but you might also want to do your own additional research into its prospects.

Beyond these considerations, the potential pitfalls of IPOs mirror those of equities in general. The allure of stocks, whether you opt for IPOs or shares that are already on the exchange, is the possibility of higher returns than many other assets. Equities may look especially tempting during periods when savings accounts offer very low interest rates – but the flipside is the potential for losing money. Share prices can fall as well as rise and may be very volatile.

Moreover, investing in shares through an IPO or any other individual shares means you will be exposed to the fortunes of one particular company. If it’s the only company in which you invest – or you only have a small number of shareholdings – you may be in danger of putting all your eggs in one basket.

For many investors, a collective investment fund, run by a professional investment manager, may be the easiest way to invest in shares. These funds, if they contain stocks, can still fall in value as well as rise. However, they enable you to spread your risk over a larger number of companies without you having to invest a significant amount of money.

If, after weighing up the potential risks and rewards, you decide an IPO is suitable for you, you will usually need an account with a stockbroker or a wealth management firm to place your investment order. If you are in any doubt, you should seek independent advice. In some government share sales, special arrangements may apply.

A glossary of IPO terms

Flotation

Also known as Initial Public Offering (IPO), new listing or new issue. It’s the first sale of stock (shares) in a company to the public.

Guide price range

The approximate price of the shares that are to be issued, presented as a range.

Intention to float

The official announcement by a company of its intention to become publicly listed. It outlines when the IPO is to take place and who may invest in it.

Offer period

The time during which investors can apply to buy the new shares. If demand is high, the offer period can close early.

Primary market

Where the new shares are issued and sold directly to investors. Any trading after that takes place on the so-called secondary market – the stock exchange.

Prospectus

Information relevant to the IPO published by the company. It outlines the firm’s strengths, strategy, market opportunity and future plans, as well as the potential pitfalls of investing in it. Decisions on whether to invest should be based on the information contained in this.

Underwriter

An investment bank or another financial institution organising the IPO.

This article has been prepared by Barclays Bank PLC and is provided to you for information purposes only and should not be construed as legal advice. Barclays accepts no liability whatsoever for any losses arising from the use of this document or reliance on the information contained herein.

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