New issues

New issues are also known as Initial Public Offerings (IPOs). An IPO is an offering of stock in a formerly privately-owned company to the general public. But when the term 'public' is applied to an IPO, it can be quite limited in reality.

Setting up an IPO

When a company wants to go public, it commissions an underwriter to help. The underwriter, usually an investment bank, will agree to buy a minimum number of shares from the issuer - effectively insuring the flotation. The underwriter will then sell on the company's shares to other buyers, usually their clients or perhaps the underwriter's broking operation.

While the underwriter charges large fees for its service, it risks getting stuck with shares worth less than the price agreed with the issuer if there is little demand for the stock.

At the next stage the company and the underwriter set the flotation date and issue a preliminary prospectus. This document gives detailed information about the business so investors can make an informed judgement about the company's prospects.

The preliminary prospectus also gives an indicative offer range (price) for the stock. This price, however, is subject to change right up to the issue and will usually be affected by perceived demand for the stock in the market and by general market conditions.

Buying stock in an IPO

Demand for IPO stock can be huge and offerings are often oversubscribed. The result is that there is a large increase in the stock price on the day of flotation.

For the ordinary investor it is not easy to get in on an IPO. The reality is that the underwriter or broker usually reserves IPO stock for its favourite clients who are often large institutional investors or wealthy private clients.

The first chance a private investor may have to buy the stock is often on the open market, where it may trade for much more than the issue price.