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Should you Buy IPOs?

Rising equity markets have brought an increase in initial public offerings (IPOs) coming to market. These new issuers, when compared to other public companies, are often younger and smaller, and are looking to raise capital for expansion. In this article, we take a critical look at IPOs to understand the benefits and drawbacks of buying these securities.

What is an Initial Public Offering?

IPOs are new shares sold to the market for the first time that are issued by a company listed on a security exchange. The public offering process enables a previously private company to become public. The first modern IPO was the Dutch East India Company in 1602. At the time, the chartered shipping company required large quantities of capital to fund shipping and trading operations. The corporation offered shares to the public to obtain the required capital.

Companies go public for a number of reasons. Young firms like the Dutch East India Company require capital to fund investments in positive net-present-value projects or to make external acquisitions. Issuing shares to public markets is often a cheaper alternative to obtaining capital than a private placement. Additionally, the process of going public is typically well publicized in the press and may lead to greater visibility not only with potential investors, but also with customers. For managers, entrepreneurs, and early investors such as venture capitalists, an IPO is a liquidity event representing an opportunity to monetize their initial investment.

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