Jargon buster: stock market flotations (IPOs)

Stock market flotations can be exciting and they do get a lot of media coverage, but the language used can be confusing. We think you'll find this a useful explanation if you're interested in IPOs either now or in the future.

‘IPO’ is one of the many financial markets acronyms that can leave novice investors baffled, but it’s actually a fairly straightforward matter. It stands for initial public offering, but might also be referred to as a flotation or ‘going public’.

You will see a lot of coverage of IPOs in the media as they tend to grab a lot of attention when they come around, particularly if they involve large, well-known companies.

IPOs can represent a great opportunity for investors to get exposure to a good company early in its corporate journey. In theory at least, they are supposed to be priced attractively relative to the financial performance of the company and its prospects.

However, they also carry risks as some can be overpriced, and there is always a chance the company in question does not deliver what investors were hoping for in the months and years following the IPO.

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What is an IPO?

IPO is a capital markets transaction whereby a company raises money by issuing shares to the public for the first time. Companies begin life as privately owned entities, with shares only available to people working within them, or specially selected outside investors.

An IPO can often be seen as a ‘coming of age’ for a company where it goes from a prospect to an established name in the business world. This is not always the case though as there are some large, household name companies that remain privately held.

Why do companies conduct an IPO?

There are a variety of reasons a company would ‘go public’ through an IPO. Essentially, it’s about raising cash. A company will choose to IPO in order to fund the next stage of its expansion, pay off debts or simply to allow the current owners to cash in their chips and move on to other things in life.

Private equity firms – a company which invests in other companies or buys them outright - typically IPO the companies they own in what is dubbed an ‘exit.’ They take the decision to do this at a point in time when they believe market conditions are favourable and deploying their capital somewhere else is likely to be more profitable.

IPOs have a number of common features which will often be referred to. Here are the most important ones:

Bookrunners and underwriters

These are the banks which carry out the transaction on behalf of the company in question. They work out what they believe to be a fair valuation, guarantee a certain minimum amount of money is raised – underwriting the fundraising - and go out and pitch the deal to potential investors.

Announcement of the Intention to Float (AITF)

This is the formal announcement made to the stock market that confirms an IPO is being launched imminently. It will have some basic details of the offering but will not have all the important information confirmed.

Roadshow

This is a series of presentations made in different locations to promote interest in the IPO. The bookrunners, underwriters and company management will tour the country, and possibly travel overseas if it is a very significant IPO, selling the story to potential investors. This is crucial to gauging interest in the IPO and how much money it might be able to raise.

Indicative share price announcement

Following their own analysis and research, plus feedback from investors, the bookrunners and other advisers to the listing company will calculate what they see as a fair price for the new shares and announce it to potential investors. It is typically given as a range rather than an exact number. For example, 70p to 90p per share.

Prospectus

This is the full breakdown of all the key information and follows on from the ATIF. It will contain all the details on what is being offered to investors and under what terms.

In some cases, an initial ‘pathfinder’ prospectus will precede a finalised one. Key details include the minimum order size investors must make, any restrictions on who can invest and rules for how soon after the deal people can sell their shares, which is known as the ‘lock-up’. 

There will also be details on the company’s financial performance, debts and various other metrics required for investors to make an informed decision.

The prospectus will also contain the ‘Use of Proceeds’ which is the explanation of what the money raised will be spent on.

Offer period

This is where the rubber hits the road. A small window of around two weeks where investors are invited to apply for the newly issued shares. When the offer period closes, applicants will be allocated shares, which is typically based on the size of their application. If an offer is very popular and is oversubscribed, share allocations may be scaled back.

Order book

A list put together by the banks running the deal of who is buying and how much they want to invest.

Allotment

The bookrunner decides how many shares will be allocated to each of the investors on the order book.

Conditional and unconditional dealing

Conditional dealing is when the shares are listed on the stock market but subject to restrictions on who can buy and sell them. If there is reason to stop the flotation during the conditional period, all trades can be unwound and money returned to investors, although this is an incredibly rare event. Unconditional trading is when these limitations are lifted, and the IPO can be considered complete.

Direct listing

A direct listing is not technically an IPO, despite the fact that it accomplishes a similar thing and people often call them IPOs.

In a direct listing, already existing shares owned by the employees of a company and other connected people are placed on a stock exchange for public purchase for the first time, without a book-building process. This is in contrast to an IPO, where new shares are created and an order book of buyers is put together in advance.