Many companies choose to go public by releasing their Initial Public Offer (IPO) to raise capital and liquidate assets. In this process, a part of the company’s equity is offered for trading to the general public. While the company enjoys many benefits such as increased market influence and prestige after the launch of an IPO, there are many risks involved for the investors.
Let’s have a quick look into the top three risks of applying for an IPO.
Allotment of shares is not guaranteed
Applying for an IPO does not guarantee that the applicant will be allotted shares. This means that the returns are not assured. Even if the applicant is able to get some stocks it is possible that he/she may be allotted only a small proportion of stocks that they applied for. Since shares get allotted on a proportionate basis, small investors may not be granted any shares at all.
One of the reasons for this phenomenon is that before an IPO is actually released there is a Pre-IPO placement reserved for big equity firms, hedges, etc. at discounted prices through which companies raise funds. The number of shares that will be offered to the public depends on how this process goes and how much equity the company has left to offer.
No history of how the shares will behave in the market
There is virtually no public data to predict how a company’s shares will perform after its IPO is released in the market. Another point worth noting is that even though going public a company is required to disclose all relevant details, it is sometimes quite difficult to determine what the loopholes might present in the company’s model and what market risks it bears.
Sometimes it is possible that due to the hype around the launch of a company’s IPO the offered launch price of the shares might be inflated due to higher demand. Later, under normal market conditions, these prices tend to fall and the investors lose their money. Uber IPO is one of the most famous offerings to back this.
Alternatively, there is a risk of losing investment if the stocks of the company do not perform as well as expected or fall due to unfavorable market conditions (volatility risk). There is lingering uncertainty about the performance of equities. In addition, if the firm goes out of business, investors stand a chance to lose their whole capital amount (absolute risk).
Investing in an IPO is suitable for investors with a high-risk tolerance. Interested traders should thoroughly research about the market conditions and familiarize themselves with the risks involved before coming to an ultimate resolution to avoid losing hard-earn money.