IPO - A Public Company Is Born
 by: Daniel Kertcher  

When a private company reaches a point in it’s development that it requires an injection of capital to expand the business, then the directors have a couple of choices. One of the most popular methods is to FLOAT the company.

Floating, also known as Listing, involves taking a private company public to raise money for company growth and expansion. Members of the public as well as fund management institutions are invited to purchase shares in the Initial Public Offering (IPO).

The Prospectus

Before any company may solicit funds from the public, regulations require that it must draw up an offer document called a prospectus, which needs to be registered with the Australian Securities and Investment Commission (ASIC). This must present enough details and financial information on the company to allow a prospective investor to make an informed choice on the suitability of the shares for his or her portfolio.

The level of information that must be provided (which can often seem overwhelming to readers) is only one requirement that must accompany a listing application. Government consumer protection legislation is one consideration, but the stock exchange itself will have its own listing criteria. Such things as fees, required documentation, reporting requirements, size of the company and number of shareholders, etc. will all figure in a listing decision. For example, one requirement of the ASX is that a company has at least 400 holders of $2,000 each.

This sale of shares has occurred on the Primary Market. The money raised from the sale of shares has gone to the company to allow it to expand its operation. The new shareholders will want to see that the company is well run, professional and efficient. To do that, the shareholders will elect a board of directors to oversee the day-to-day running of the company. They do this by voting in accordance with the size of their shareholdings. This might result in, say, the election of a six-person board which selects its own chairman. Once a year, the board of directors must conduct an annual general meeting (AGM) to report to the shareholders on the company’s progress. Well in advance of the meeting, a copy of the annual report will be provided to all shareholders. All shareholders are welcome to attend the AGM’s.

Investors, particularly share traders, purchased the shares in the float with a view to selling them in the future to make a capital gain. They must therefore have a market at which to sell the shares. This is where the shareholders return once again to the stock market.

When the investor sells his or her shares, the money raised does not go to the listed company, instead, the money, minus broker commission (brokerage) goes to the investor. This is known as the Secondary Market. The Secondary Market is where the are shares are traded once they have been purchased in the IPO.

This may seem staggeringly obvious; however, it raises an important point. Many people who invest in shares for the first time do not fully appreciate that the value of a company’s shares is not directly related to the performance of the company, or who the company is. Instead, the value of the shares is based on the public’s perceived value of the company. What Telstra does as a company is not as important as what the public perceive the value of Telstra’s shares to be. There are many examples of companies that are very sound and well run, but are undervalued by the public. Alternatively, there are companies which don’t even produce profits whose share prices have skyrocketed. You only have to think back to some of the American Internet stocks such as Yahoo and Amazon.com for examples. These two companies had not even produced profits when they floated, yet their share prices rose incredibly fast, making the original owners billionaires literally overnight! It is this variance in share price and public perception that encourages share investors and allows them to make consistently high returns from the stock market.

The Bottom Line

The bottom line is that you cannot expect to be consistently successful as a share trader or investor by simply buying shares in companies that sound interesting. You must know how to investigate the company and to study the share price performance to determine which shares have the greatest potential to perform.