An initial public offering is the moment a private company becomes a listed company. For investors, it is an opportunity to buy shares at the offer price before trading begins. Understanding how the process works — and its limitations — helps investors approach IPOs with realistic expectations.

How an IPO works

A company planning to list typically appoints advisers, including a lead manager (often an investment bank or broker), lawyers and accountants. Together they prepare the company for listing, conduct due diligence and prepare the offer document.

In Australia, a public offer is usually made under a prospectus lodged with ASIC. The prospectus sets out information about the business, its financial position, the offer terms, the use of funds, the directors and the key risks. The company must also satisfy the admission requirements of the exchange on which it intends to list.

The offer price is set before the shares begin trading. Once the offer closes and shares are allocated, the company lists and its shares can be bought and sold on market.

Reading the prospectus

The prospectus is the most important document for anyone considering an IPO. It can be lengthy, but several sections deserve particular attention: the investment overview, the financial information, the risks section, the use of funds, and details of directors, related-party arrangements and escrow.

  • How will the money raised be used?
  • Are existing shareholders selling shares as part of the offer?
  • What are the historical and forecast financials, and what assumptions sit behind them?
  • What are the specific risks identified by the company?
  • What proportion of shares will be held in escrow after listing?

Allocation and availability

Demand for an IPO can exceed the number of shares available. When that happens, allocations may be scaled back, and investors may receive fewer shares than they applied for — or none at all. Some offers are reserved for particular groups, such as institutional investors, broker clients or existing shareholders of a related company.

Availability and allocation can vary significantly from one offer to another, and participation in one IPO does not imply access to future offers.

Listing day is not the whole story

Much attention is given to how a company's shares trade on their first day. A strong debut can attract headlines, but first-day performance is not a reliable indicator of how the shares will perform over time. Equally, shares can trade below the offer price from the outset.

After listing, a company's share price is influenced by its results, market conditions, sector sentiment and broader economic factors — the same forces that affect any listed company. Newly listed companies may also experience additional volatility as trading patterns establish and escrow periods expire.

Where IPOs fit in a portfolio

IPOs can offer access to companies at the point they join public markets, which some investors value as a way of adding new businesses and sectors to a portfolio. As with any individual share investment, concentration risk is a key consideration: investing heavily in a single new listing ties the outcome to one company.

This article provides general information only. Before applying for shares in any IPO, read the prospectus in full and consider whether the investment is appropriate for your objectives, financial situation and needs, ideally with independent professional advice.