An initial public offering (IPO) is when a private company offers shares to the public for the first time. It enables the company to raise equity capital from the public provided it meets the requirements of the stock exchange it wishes to list on, such as the ASX.
The company is then able to access a large pool of investor capital to fuel expansion and growth, pay down debt, or for working capital.
Why go public?
Many growing and successful private companies consider listing on the ASX via an IPO at some stage. A successful listing and IPO can accelerate growth and open new business opportunities.
The process can help raise the profile of a company as it transitions to the public market. It provides an opportunity to generate publicity and benefit from the prestige of being listed on a major stock exchange.
An IPO can also improve the liquidity of a company's shares, which can be helpful to its management in several ways. It can allow founders, executives, or staff to quickly offload their existing shares without finding a private buyer. It can also facilitate a company offering shares or stock options as part of their staff remuneration to attract high-quality employees to their business.
And private equity and venture capital investors often work towards an IPO as an exit mechanism for their investment.
What is the difference between an IPO and a direct listing?
A company wishing to list on the ASX can do so via an IPO or a direct listing. In an IPO, new shares are offered to the public. The company, therefore, sells part of itself by issuing new shares.
In a direct listing, existing shares held by current investors are sold to the public, but new stocks are not issued. A direct listing allows companies to become listed on the ASX without raising additional equity capital.
Companies that undertake a direct listing have different goals from companies conducting IPOs. A direct listing increases liquidity for existing shareholders but does not raise additional capital for the company. A company undertaking a direct listing will still enjoy the other benefits of going public, such as increased public awareness and institutional interest.
Unlike an IPO, a direct listing does not utilise the services of underwriters. This means the costs of a direct listing are generally lower than an IPO's. But it also means the company conducting the direct listing has to be attractive enough for the market. Companies that can consider direct listings often have a strong brand identity and easy-to-understand business model and do not require additional capital.
The result of an IPO or direct listing is that shares in the issuing company are available to trade on the stock market. Once this occurs, any individual investor or retail investor with a trading account can purchase shares in the company.
Underwriters and the IPO process
The IPO process requires an underwriter – usually an investment bank. They work closely with the company conducting the IPO to help it prepare.
The underwriter will assist with determining the amount of money to be raised, the type of shares to be issued and preparing the relevant offer documents required by the exchange. The underwriter will determine the offer price of the shares, buy from the company, and sell them to investors via their distribution network.
Conducting an IPO
- Appointing advisors, including an underwriter, legal counsel, accountants, and technical experts
- Considering and deciding on the structure of the initial public offering
- Determining whether the company can meet the listing requirements of the relevant stock exchange (the ASX in Australia)
- Conducting IPO due diligence to ensure the prospectus contains the information required by law and does not contain any false or misleading information
- Preparing disclosure documents, including the prospectus and marketing materials for potential investors
- Undertaking any required pre-IPO restructuring
- Commencing marketing to institutional investors to generate interest in the offer
- Lodging the prospectus with the relevant governing body (the Australian Securities & Investments Commission (ASIC) in Australia)
- Applying for admission to the official list with the relevant stock exchange (the ASX in Australia)
- Processing of the listing application by the relevant stock exchange
- Commencing marketing to retail investors, who brokers from their retail distribution networks usually solicit
- Opening and closing of the offer period
- Funding becomes available to the company, the IPO sares are issued, and trading commences on the stock exchange.
The direct listing process
Where a company chooses to undertake a direct listing rather than an IPO, it will have to follow a similar process:
- Appointing advisors (likely including the advisory services of an investment banker)
- Considering and deciding on the structure of the direct listing
- Determining whether it can meet the listing requirements of the stock exchange
- Preparing disclosure documents – the ASX Listing Rules require a prospectus to be lodged with ASIC for admission to the official list, however where the listing does not involve a capital raising, the ASX may agree that an information memorandum is sufficient
- Lodging the disclosure documents and making an application for listing
- Processing of listing application
- Trading commencing on the stock exchange.
Advantages of conducting an IPO
An IPO can result in a significant cash windfall for a company due to selling ownership. It can use the additional capital to invest in expansion, pay debt, or pursue acquisitions.
Other advantages of being listed on a stock exchange include the following:
- Broader access to the investing public to raise future capital
- An increased ability to fund acquisitions using scrip rather than cash
- Lower costs of capital for equity and debt
- Raising the profile of the company
- Allowing early investors to exit (although with an IPO, there are likely to be restrictions on the number of shares that early investors can sell for a period after listing).
And the disadvantages
Of course, there are some disadvantages to consider. These include:
- The expenses associated with conducting an IPO or direct listing, which can be considerable
- Ongoing disclosure requirements imposed by the stock exchange, which mean financial, accounting, tax, and other business information must be disclosed
- The disclosure obligations that apply to public companies can result in increased legal, accounting, and management costs
- A potential loss of control for owners of the company arising from dilution and the need for shareholder approval under the ASX Listing Rules
- The diversion of management focus that an IPO or direct listing will necessitate, which, if not carefully managed, can impact the underlying business.
Some companies may consider the pros and cons of pursuing an ASX listing and instead decide to pursue an alternative, such as remaining private or soliciting bids for a buyout.
What are lock-ups and flipping?
Lock-ups prevent company insiders from selling shares when a company 'IPOs'. Lock-ups usually apply to a company's founders, owners, managers, and early investors. These insiders are prohibited from selling their shares for some time after the IPO.
Lock-ups can help grease the wheels for an IPO by ensuring a large volume of shares is exempt from being sold upon listing. This may help prevent initial dips in the share price when a company does list on the stock exchange.
Flipping is when you invest in an IPO and exit quickly, which some retail investors or institutions may be able to do.
This usually involves determining that a share's IPO price is below the company's valuation. Getting on the right side of this equation can potentially result in a healthy profit on IPO day. This can make IPO investing lucrative for initial investors.
Recent IPOs in Australia
IPOs have been around for as long as stock exchanges, so they're likely to remain a key common channel for public capital raisings for the foreseeable future.
The very concept of the IPO has been expanding in recent years. The cryptocurrency world has its own version of an IPO – the initial coin offering (ICO), sometimes called the initial token offering (ITO).
The ASX IPO market has been subdued in 2023. Following a record year for listings in 2021, activity declined in 2022 and retreated further in 2023 after a dozen increases in the cash rate. There were just 14 IPOs in the first half of 2023, down from 59 in the same period of 2022.1
The majority of listings in 2023 have been in the materials sector, with lithium and gold companies both well-represented. Most of 2023's IPOs have small caps. However, some larger capitalisation companies have been listed, including Light and Wonder Inc (ASX: LNW) and Redox Limited (ASX: RDX).
Uncertainty in global markets, a slowdown in economic activity, and tighter monetary conditions are challenging capital markets. These conditions have not only placed pressure on capital-raising activities but have also weighed on the performance of companies post-listing.
Redox shares debuted on the ASX in July and are hovering around their listing price. However, shares in Light and Wonder, which were listed in May, have gained more than 40%.
The ASX publishes details of each upcoming IPO on its website.
Investing in IPOs
Like all investments, investing in IPOs or direct listings involves risk.
However closely you study the disclosure documents, the reality is that investors cannot precisely predict how a newly listed company will perform. Any number of factors (including those outside a company's control) can impact the performance of listed and unlisted companies. These may be economy-wide (such as a pandemic or recession) or changes affecting a specific industry.
As such, we tend to see various outcomes for different IPOs. Some become incredible success stories, but others prove to be spectacular failures.
Valuing a company is a complex and demanding task at the best of times. Valuing a company that is pursuing an IPO is even more challenging. Companies that conduct IPOs tend to be younger companies in their growth phase. Some are not even profitable yet.
This makes using traditional valuation metrics like the price-to-earnings (P/E) ratio very difficult. Instead, investors must look at other metrics like revenue growth, customer retention, and brand strength. While these numbers are helpful, they do not guarantee future profits.
Frequently Asked Questions
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An IPO is when a private company becomes a public entity by offering its shares to the public for the first time. It is a significant milestone in the life of a company that signifies its readiness to abide by the greater scrutiny and regulations of the public market. Companies decide to IPO primarily to raise capital, although an IPO can also serve as an exit strategy for founders and early investors.
The IPO process begins with a company appointing underwriters (usually investment banks) to guide the IPO process, including pricing the shares, ensuring regulatory compliance, and managing the distribution of shares. The company then prepares and presents a prospectus that details its financial performance, business model, and prospects. Following regulatory approval, the company's shares are listed on a stock exchange like the ASX, making them available for purchase by the general public.
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In Australia, an initial public offering (IPO) is the process through which a private company becomes a publicly traded entity by offering its shares to the Australian public for the first time. The journey begins with the company appointing underwriters who help determine share prices, manage regulatory requirements, and handle marketing.
The company creates a detailed prospectus that provides potential investors with insight into its financial health, business operations, and future growth plans. This is critical for building investor confidence. Once the regulatory standards of the Australian Securities and Investments Commission (ASIC) and the Australian Stock Exchange are met, the company's shares are made available to retail and institutional investors.
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It depends on the perspective of the relevant stakeholder. For a company, an IPO can be a significant growth opportunity. It provides access to capital from public investors, which can be crucial for expansion, innovation, or consolidating debts. It also enhances a company's public profile and credibility, potentially opening new business avenues. Additionally, it can offer an exit or profit-realisation strategy for early investors and founders.
However, IPOs come with their own set of challenges. For a company, going public introduces a higher level of regulatory scrutiny and the need for greater transparency with shareholders. This can lead to increased operational costs and shifts in management focus. For investors, while IPOs can offer the chance to invest early in potentially high-growth companies, they also carry risks. The initial performance of IPOs can be unpredictable, and not all IPOs yield high returns. Therefore, assessing whether an IPO is 'good' or 'bad' will depend on the objectives of the IPO, the relevant company's subsequent performance, and the perspective of the individual undertaking the assessment.
