An initial public offering occurs when a company goes from being privately held to publicly owned with shares trading on the stock market. Often a new stock will go up significantly on the first day of trading, and investors who get in early can make a nice profit. The offering price and opening share price of an IPO are a big part of the first-day results.
Steps of an IPO
To go public and sell shares into the stock market, a company hires an investment bank to underwrite the initial share offering. The lead investment bank helps the company put together a prospectus and spread the information about the pending IPO to other investment banks and brokerage companies.
On the day before the IPO, the underwriter allocates the shares involved in the initial offering to other investment banks. These banks or brokerage firms offer the shares to their best customers, who are primarily institutional customers.
The next morning – the date of the IPO – the shares start trading on the stock market. The investors who agreed to buy shares from the investment banks before the IPO already have their shares and can sell or hold the shares on the opening trading day.
The Offer Price
The offer price for an IPO typically is set a few days before the initial offering date. The lead underwriter for the IPO sets the offer price based on the bank's analysis of the company's value and the projected demand for its shares. In the days before the IPO, the banks and brokerage firms which will receive the shares ask their customers about the interest in the shares at the projected price.
The offering price is set in the last couple of days before the IPO. This is the price paid by the institutional investors who commit before the IPO to buy shares at the offer price. Individual investors rarely get an opportunity to buy IPO shares at the offer price before trading begins.
The Opening Price
On the day of the IPO, the investors who bought at the offer price already own shares when the stock market opens. Some of these investors will offer shares for sale at the opening of the market. The initial trading price will be determined by the number of buy orders lined up to buy shares on the open of the stock exchange.
The underwriter of the IPO shares attempts to set the offer price at a level so that the share price will immediately start to trade at a higher value when the shares start trading on the open stock market. If the IPO works as planned by the underwriter and the new IPO company, the opening price will be higher than the offer price.
Getting Shares at the Offer Price
If there is a pending IPO and you want shares of the stock, ask your broker to try to get shares at the offer price. If the broker can get the shares, you will be able to buy them at the offer price before they start trading on the stock exchange. In reality, this rarely happens for individual investors with no connection to the IPO company or a large trading history with one of the banks or brokers offering the initial batch of shares.
IPO shares at the offer price go to large institutional investors who do a lot of business with the brokerage firms. A brokerage firm makes itself look good by moving a large block of IPO shares to its customers, and the institutional customers get a chance to make a quick profit in the share price increase between the offer price and the opening price.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.