What is an Initial Public Offering (IPO) and how do you invest in one?

Every now and then, the Business Times publishes big news about some company's upcoming IPO (Initial Public Offering).

This might sound like just another meaningless acronym, but for those who follow the goings-on in the stock market, an IPO is a big event. What does this really mean?

WHAT IS THE MEANING OF AN IPO (INITIAL PUBLIC OFFERING)? 

When a company starts to grow in profitability, the next step in its growth is often to become a public company. Companies need to be of a certain value and be able to abide by various regulations before they can go public.

What's the difference between a private and a public company? A private company is one whose shares are privately held. For instance, if you and your three best friends decide to start a business together, it's likely the shares of the company will be privately held by the four of you. On the other hand, a public company is one whose shares are held wholly or partly by the public. The public buys these shares on the stock market.

An IPO is the process of newly issuing a hitherto-private company's stocks to the public on the stock market. After the IPO, the company goes from private to public.

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WHY DO COMPANIES WANT TO GO FOR AN IPO? 

Companies use IPOs as a way to raise capital and help themselves grow. By buying the company's stock, shareholders are offering the company capital, and this capital is then used to grow the company. It's like your cousin asking if you want to invest in his company, but on a much larger scale.

For the founders and initial investors of a company, an IPO is also the chance to "cash out" and, for some, become overnight millionaires after years of building the company.

IPOs also give companies a lot of public exposure. A company needs to be relatively big in order to qualify for an IPO, but the exposure in news reports about an impending IPO can turn a company into a household name. And this, in turn, can boost the company's performance on the market.

One example is Gojek, the Indonesian ride-hailing start-up. After announcing that they were thinking of going public last year, their profile rose significantly in Singapore, where they now also operate.

WHAT ARE THE DOWNSIDES AND RISKS OF AN IPO? 

An IPO sounds like a great way to raise capital and the company profile. But why don't more companies do it? Well, IPOs do come with some hassles and disadvantages.

Before an IPO, a company is put under a great deal of scrutiny. They need to file financial statements and disclose a lot of information that may not previously have been known to the public. And this can result in disaster if it turns out that they are not as profitable as previously thought.

The prize for fiasco of 2019 should go to WeWork. They filed for an IPO earlier this year claiming a $47 billion valuation. But in the weeks that followed, their filing documents revealed massive losses and a shaky financial model. In other words, the IPO paperwork revealed the harsh truth about the company's financial standing.

And once this information came to light, a cloud of negative publicity started to blow over WeWork, with allegations of sexism and a toxic work culture being made. That was the beginning of the end. In just two short months, WeWork has gone from hoping for an IPO to being bailed out by SoftBank.

Other than the possibility of revealing dirty secrets, IPOs are also very expensive endeavours. In the lead-up to an IPO, companies spend eye-watering amounts of money on underwriters, lawyers, auditors and registration fees.

And once the IPO has been pushed through, the company has to adhere to lots of regulatory requirements and disclosures, which not only force them to be more transparent moving forward, but can also result in higher administrative labour and costs every year.

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The founders and initial shareholders also cede control of the company by going public, which means the pressure of meeting targets gets a lot heavier after an IPO.

So, companies must consider carefully the pros and cons before deciding to go for an IPO. On our own shores, PropertyGuru announced earlier this year that they were considering an IPO on the Australian Securities Exchange. But a few weeks ago, they pulled out, citing uncertainty in the IPO market.

That being said, the last few years have been filled with high profile IPOs, such as the following.

HOW TO INVEST IN AN IPO IN SINGAPORE

To invest in an IPO, the key difference is that you need to first determine which companies are planning to go public, whether through following business news or by word of mouth. You will, of course, need a CDP account to invest, just as you would when investing on the stock market.

You can then apply for IPOs through a bank account that's linked to your CDP account. For instance, DBS and POSB let you apply for IPOs via ATM machines and internet banking platforms. Apply for the shares, pay for what you have ordered and you will be notified if your application is successful.

XIAOMI IPO 

Everyone in Singapore knows the Chinese electronics and smartphone giant that has become renowned internationally for offering great specs at low prices. Founded in 2010, the company has become one of the world's biggest tech companies in less than a decade. Last year, they went public on the Hong Kong Stock Exchange at HK$17 (S$2.95) per share multiplied by approximately 2.18 shares, raising about $4.72 billion.

KOUFU IPO

The Koufu chain of coffee shops and food courts has become ubiquitous in Singapore. The local company, which was founded in 2002 by a bee hoon and nasi lemak seller, now operates 57 outlets in Singapore and one in Macau. Their IPO last year comprised about 97 million shares offered at $0.63 each, raising $74.3 million for the company.

PROPNEXT IPO

Hire a real estate agent and there's a good chance they'll be from PropNex, which is one of Singapore's largest property agencies. Last year, they went public, with an IPO of 42.5 million shares priced at $0.65 per share, raising net proceeds of $38 million and giving them a market capitalisation of $240.5 million.

LYFT IPO

Lyft is one of the ride major sharing services in the world. They operate in lots of countries including the US, Canada and Singapore, and are Uber's biggest competitors. They went public on NASDAQ earlier this year, selling 32.5 million shares at US$72 (s$97.96) each, which enabled them to raise $2.3 billion.

SPOTIFY IPO

Spotify is one of the biggest music streaming services in the world. In 2018, they went public on the NYSE, but with the twist-none of these shares were made available to the public, instead being sold exclusively to institutional investors.

HAIDILAO IPO

The Chinese hotpot chain has revolutionised hotpot in Singapore, China, Malaysia, Australia, Canada, Indonesia and more by offering stellar service and the infamous noodle dance. Their 2018 IPO on the Hong Kong Stock Exchange raised about $963 million, with 424 million shares sold at $2.27 each. No wonder the founder of the company has become a naturalised Singapore citizen and is now the Republic's richest man.

This article was first published in MoneySmart.