Initial public offerings (IPOs)
Understanding risk in an IPO
When a company decides to offer shares to the public for the
first time, it must go through a process known as an initial public
offering (IPO), or public float.
Here we explain why a company might go public and things you
should consider before investing in an IPO.
What is an IPO?
An IPO or 'float' is where a company offers shares to the public
for the first time. The company may want money to grow the business
or repay debt, or the founders may want to exit or reduce their
investment. Most IPOs involve listing the company on a securities
exchange, such as the Australian Securities Exchange (ASX).
How to decide whether to
invest in an IPO
The best way to decide if you should invest in an IPO is to read
the prospectus. The IPO prospectus must
contain key details about the company and the float, and companies
need to lodge this with the Australian Securities and Investments
If a company issues a supplementary or replacement
prospectus, check it very carefully. It may be a sign that the
original prospectus was inadequate.
The details in the IPO prospectus will include:
- information about the company, its operations and financial
- the number of shares on offer
- how the money raised will be used
- how to apply for the shares
- the risks associated with the offer.
Our prospectuses webpage has more information
on what to look for in this important document.
Your IPO checklist
Investing in an IPO can be a difficult decision because there is
no market price for the shares (that would show what other people
are prepared to pay for them). Also, the business will often not
have a track record or will go through significant change as a
result of the IPO.
Check the IPO prospectus to answer these questions:
- Sector - Do you understand the sector the
company operates in, or plans to operate in?
- Competitors - Who are the business'
competitors and why does the company think it can compete with
- Financial prospects - Do you understand the
financial statements? Have revenues/profits been growing? If the
company is not profitable, do you get a clear sense of when (if
ever) it might be profitable? Companies at an early stage of
development are a much riskier investment proposition.
- Relative value - What is the price-earnings ratio (P/E ratio) of
the company? How does this compare with its competitors? The P/E
ratio will help you to get a sense whether the IPO is fairly
priced. Generally, a higher P/E ratio means investors expect higher
- Dividends - Does the company intend to pay a
dividend? If so, when is this expected?
- Purpose of float - How will the company use
the funds raised through the IPO?
- Licences - Does the company have all the
necessary licences and permits to operate? If not, when will it get
- Directors - Are the company's directors and
managers paid what you would expect for the company's size and
industry? Do the directors and managers appear to have appropriate
skills and experience? Check that they are not listed on ASIC's
Banned and disqualified register. The prospectus should
disclose if any of the directors have managed a company that failed
in the last few years.
- Advisers - How much are independent advisers
paid as a percentage of the funds raised by the IPO? If the fees
exceed 10% then you should consider whether the company's advisers
are being fairly remunerated. The more money that goes to advisers,
the less that is available to the company.
- Risks - Is the risk disclosure section
detailed and specific to the company? Vague language or general
disclosures (such as warning that the price of shares can go down)
could be a sign the company is not telling you everything you need
If the answers to any of these questions raise doubt in your
mind about the company's prospects, get professional advice before
investing. Alternatively, look for an investment you can understand
more easily or, if you want to take a chance with the IPO, only
invest money you can afford to lose.
Some IPOs are highly speculative and the share price can
fall quite quickly. For example, a mining company's mineral
exploration may not be successful, and smaller companies,
particularly from emerging market jurisdictions, can be at an
increased risk of failure.
Can you trust financial
As well as reading the prospectus, you may look for other
sources of information to help you decide whether to invest in an
IPO. Be careful when relying on recommendations by financial
commentators who write for investment newsletters, chatrooms or
These financial commentators may not be experts in IPOs and may
rely on reports from analysts paid by the IPO issuer. In some
cases, financial commentary may be discreetly sponsored by the
company looking to raise capital. What looks like an independent
evaluation may actually be advertising in disguise.
Before you invest, read as widely as possible and learn as much
as you can about the industry, the company and its competitors.
This will give you the best chance of making an objective decision
about whether to invest in the company.
ASIC's role in IPOs
ASIC does not endorse, approve or verify the content of
prospectuses, but all prospectuses must be lodged with ASIC before
any securities are offered to the public. To check if the issuer
has lodged a prospectus, see
ASIC's OFFERlist database.
ASIC reviews most prospectuses to assess whether the disclosures
appear to comply with the law. However, these assessments are only
based on the information provided; ASIC may not know if a company
has failed to disclose negative information.
Companies do not have to meet any merit-based criteria to list,
they just need to have a minimum number of shareholders and meet an
asset or profit test. This can include the money they raise in the
If you read something in a prospectus that you think is
incorrect or misleading, you should not invest until you get a
satisfactory explanation in writing or an amended prospectus is
issued. You can also
make a complaint to ASIC about the prospectus.
Investing in an IPO can be risky, so do plenty of research. If
you still have questions you can't find answers to, or if you have
any doubts, don't risk your money unless it's an amount you can
afford to lose.
Last updated: 03 Apr 2018