For a private business to become a public company, it must convert its structure and comply with the legal requirements of a public securities exchange. This conversion process is known as an Initial Public Offering (IPO), or as it’s often called in Australia, a “float.”
An IPO is a significant event for a company, as it allows them to raise a substantial amount of money from the public for the first time.
The Prospectus and the Subscription
To become a public company, the business must first prepare a document called a prospectus. This is a comprehensive guide that outlines all the relevant commercial and financial information about the company, including a detailed list of the risks involved for investors.
If you want to buy shares in a company’s IPO, you must complete the application form included in the prospectus. When you obtain shares in this way, you are said to have “subscribed” to the issue. A key benefit of this is that investors usually don’t have to pay any transaction costs to get their shares.
The Underwriter’s Role
Most floats are managed by an underwriter, which is usually a large broking firm or a financial institution. The underwriter’s job is to guarantee the success of the IPO. If the issue is undersubscribed—meaning fewer shares were applied for than were available—the underwriter agrees to buy the leftover shares.
On the other hand, if more shares are applied for than are available, the issue is oversubscribed. In this scenario, investors may not receive as many shares as they initially applied for, as the demand exceeded the supply.
Setting the Price and the First Day of Trading
The price at which shares are offered is set through careful consultation between the company and its underwriter. Their goal is to find the maximum price that still ensures all the shares will be sold.
From the day of listing onward, the shares can be traded on the stock exchange. The market’s reaction on the first day of trading can tell you a lot about the issue’s success:
- If the market believes the issue price was set too low, and/or the IPO was oversubscribed, the share price will usually take off on the first day of trading.
- Conversely, if the issue price was too high and/or the IPO was undersubscribed, the price will likely fall on the first day of trading.
References
- ASIC – MoneySmart. (n.d.). Initial Public Offerings (IPOs). https://www.moneysmart.gov.au/investing/shares-and-other-investments/initial-public-offerings-ipos
- Investopedia. (2023). What Is an IPO? Initial Public Offering. https://www.investopedia.com/terms/i/ipo.asp
- The Australian Financial Review. (2022). How does an IPO work in Australia? https://www.afr.com/investor/investor-guide/how-does-an-ipo-work-in-australia-20220914-p5b5w3