Deliveroo, Asda, Jaguar Land Rover. What links these three companies? Yes, Mrs Smith likes the products of all three. But the answer I was looking for was that they’re potentially looking to float on the London Stock Exchange this year.
Now, while most of us are familiar with buying and selling shares in companies, IPOs for the most part are a grey area for retail investors like ourselves. So let’s clear away the mist and make it simple.
What is an IPO?
IPO stands for initial public offering and is when a business decides to change from being a private limited company (denoted by the letters ‘ltd’) to a public limited company (so it becomes a ‘plc’). This involves taking a chunk of shares that are in private shareholders hands and offering them to the public.
Why do firms go public?
Usually it’s an exercise in raising funds for the business. Let’s say a business has one shareholder, the founder of the company. If he or she needs expansion or capital expenditure funds, then (s)he could sell 40% of his/her shares via an IPO to the public. If 40 shares were sold at £100 each, the founder still owns 60% of the business (and importantly still has control) but has raised £4,000. Of course, the numbers involved in IPOs are much bigger than that!
How can I invest in IPOs?
Most of our readers are likely to be interested in how to invest in firms that list on the London Stock Exchange (LSE), and depending on the size of the company, the IPO will either see the shares listed on the main market or on AIM, the market for smaller growing companies.
You can either invest directly via the company or via a stockbroker. There are pros and cons of both options, but buying through your broker is the easiest method as they take care of a lot of the paperwork and execution for you. Some even help to allocate the shares into your ISA or SIPP.
One thing to watch out for is that some firms don’t target retail clients, choosing to raise funds for the IPO via institutional investors. In this case, you would have to wait until the shares are traded on the LSE before getting involved.
It’s always worth checking with the broker about what the IPO price is going to be before making your mind up. Prices are often quoted in a band, so if the expected IPO price is at the top end of the band, do some research yourself. Is the valuation fair in your opinion? This is worth looking at because on the first few days of trading you can see large volatility as the market adjusts to demand and supply.
Investing in IPOs can be very profitable. Take Auto Trader. It floated in 2015 at 265.5p a share and has doubled in value since, never dropping below the IPO price. But also remember that business owners want list at the optimum time to raise the maximum amount of cash via an IPO and there’s no guarantee the price will rise (think Aston Martin and Quiz). But as a patient investor, if you can pick the right IPO then you could be set fair to hold a growing stock for years to come.
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Jonathan Smith does not own shares in any firm mentioned. The Motley Fool UK has recommended Auto Trader. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.