I wish I knew what an was, but I’m too embarrassed to ask

An initial public offering (IPO) represents the first time that a company sells shares in itself to institutional investors (such as pension funds) and often also to individuals (retail investors). This process is also known as “floating” or “going public”.

Companies go public for a wide range of reasons. They may want to raise funds for expansion and choose to do so by selling part of the company rather than borrowing the money. Alternatively, the current owners – perhaps the original founders, or a private-equity fund – may wish to “exit” (ie, cash in on their investment).

An IPO is underwritten by one or more investment banks, which typically earn large fees from the process. A prospectus with details of the company and the offering is issued to potential buyers. The IPO price is typically based on expected demand from investors. If demand outstrips the number of shares on offer (the IPO is said to be “oversubscribed”), then the underwriter will have to decide how to allocate the shares. If there aren’t enough buyers, then the underwriter agrees to purchase the surplus (hence the term “underwriter”).

Occasionally an IPO will be pulled due to lack of demand, but this is unusual. More often, a newly-listed company’s share price will enjoy a “bump” on the first day of trading. However, unless you are allocated shares before the trading starts – unlikely with a “hot” stock – then you are unlikely to benefit.

Many studies suggest that IPOs underperform over the long run, though sometimes government privatisations (where there is an incentive is to price at a level where buyers – who are also voters – can make a short-term gain) can offer good opportunities. This weak performance is at least partly because IPOs are more frequent near market tops than bottoms, because shares in new companies are easier to sell when investors are clamouring for equities rather than nursing their wounds after a market crash.