What’s an IPO and why should you care?
Today I want to help you understand what an IPO is. Also, this post was born out of the need to explain the whole process to someone special. I feel the need to put this in here — although it will be irrelevant to all but one of my readers. LB, I hope this ends up being better than a voice note.😉
Alright, so what’s an IPO and why in the world you should you care about it?
I’ll use as little finance terminology as possible so as to keep things simple. Also, we’re going to apply a minute variation of solving by ‘first principles’ to this. (First principles is a concept that requires you to establish notions, solutions or pretty much whatever you need to do by beginning with the very fundamental truths/assumptions about the subject matter. It kind of births more accuracy in the end.)
We’re going to start this journey of understanding with the end of the matter. And after, we’ll rip it all apart by delving in with a first principles approach:
An IPO is the very first stock offering by a company to the public. You should care because stocks can make you a lot of money through dividend payments or stock trading.
If you understood that and you think you’ve had enough, feel free to stop reading and move on with your life. (Life is quite short after all.) Or just skip to the last two paragraphs. I really don’t mind. But if you want to learn more and/or you’re excited about the first principles approach that I talked about earlier, be thrilled with a good story and see a picture of Sergey Brin, then stay with me. Full disclosure, this won’t seem like a finance class — at all. Don’t say I didn’t tell you…lol.
Let’s take some keywords from our golden definition. The first one I want to tear apart is ‘company’. In simple terms, a company is a group of people. That’s the most fundamental thing. Now let’s build upon that. You see, this group of people have a common objective. And in terms of business, they try to profit from achieving their goal. A company is less about buildings and legal documents and more about the people and the dream. And some companies really have big dreams. Google, for example, embarked on a quest of making pretty much any kind of content accessible on the internet. The visionary Larry Page, co-founder of Google, once woke up in the night after a dream with a question: What if you could really download the entire internet onto your computer?
(We’re steering off course a little bit. But stay with me.) Larry’s revolutionary vision charmed his friend, Sergey Brin, and they set out to work together to make this idea a reality. And so in essence, the company, Google, was not formed when they had their paperwork done in 1998 or when moved into an office. It was formed at the very the moment Sergey said “Larry, I’ll help you make this happen.” (Hey, maybe that’s not exactly what Sergey said but when I interview those two one day, I’ll be sure to let you know. Someone should make Sergey Brin read this!!!)
That Google has now evolved into a much larger company called Alphabet Inc. Alphabet is one of the most valuable companies in the world. As at yesterday (15th March 2018), the company was valued on the US financial market at $799.81bn. That’s deep.
So companies are groups of people who can have audacious goals and SHOULD stop at nothing to pursue dreams them. But then having dreams is not enough. You actually need the capacity to make things happen. For a business owner, that means you probably have to hire great talent or utilize crucial technology (and some other things I don’t have to mention because it’s out of the scope of today’s article). Building this kind of capacity comes at a price and is almost always acquired in exchange for money. This kind of money is referred to by many as capital — although capital actually goes beyond just money. However that’s another day’s story.
So what happens when you don’t have enough capital to run your business? You’d either raise money or let your venture die. There are two ways to raise money: debt financing or equity financing. Debt financing is basically taking money from investors with the promise of paying them back sometime in the future. This often comes with interest attached to it, often paid out to investors over a regular period of time. For example, a company, on behalf of the Government of Ghana, used debt financing to raise some money (about $2bn) for development in our energy sector through a financial instrument called a bond. You can think of a bond as a glorified loan with sweeter perks and conditions. I want us to stay on track this time so I’m not going to go off track….but I’ll leave you with a photo of the man at the reins of #Mofep — just because I can…lol. It’s a good reading break. Deal with it:
With equity financing on the other hand, an investor wouldn’t get repaid his invested money. In fact, there is no money lending. Instead, an investor gives his money to a company/firm in exchange for a stake/ownership in the company known as equity or stocks or shares. This means that if the company does well and gets to make a lot of money, these investors may get to share in the profits. That’s awesome but quite risky. And so you have to find a company that’s really going to be worth it. You have to measure their profitability or if you’re more ‘insane’, then you skip valuating then and just believe in their dream. High risk, high reward right?
Update (June 2018): Believing in a good dream, does reward. Ask Andy Bechtolsheim. He was Google’s first investor.
There are many ways to companies offer shares. Let’s classify them into two: private offerings and public offerings. Private offerings are, well private😄. It simply means that not everyone will get to invest in the company that’s trying to raise money. Often, you wouldn’t even hear about it — trust me. Only a select few do. And most time these are investment firms. A good example of a private offering is DoorDash’s 2nd private equity financing round that took place last month. DoorDash is a [food] delivery startup will soon lead the race in its market at very impressive rate. The company was able to raise a whopping $535m in its last financing round last month. This was done with the help of some top investment firms like Sequioa Cap, Kleiner Perkins and GIC.
Public offerings on the other hand, are well public…lol. There are many variations of public offerings. However, when it happens for the first time, it’s that’s when it’s an IPO. Because an IPO stands for Initial Public Offering. Through this process the company can raise money from a large pool of investors. This also allows early investors to cash out and sells their shares in exchange for money. For example, when DoorDash finally has its IPO in the future, this will give firms like Sequioa the opportunity to cash out — just like Sequioa did during Google’s IPO after an earlier investment in Google.
The company is able to pool in a lot of money through this process and without any obligation to pay back that money. To make sure that the company does do well, ‘major investors’ normally would establish a board to regulate the actions and decisions of its leaders. Often investment banks like JP Morgan Chase, IC Securities and Goldman Sachs handle the IPO process for companies at a fee. They do a number of things like valuating the company to make sure that the stock is priced rightly so that value is exchanged for the right amount of money — not way higher, nor way lower. This helps investors gain better value for their money.
So why should you care about IPOs anyways, what’s so great about stocks if you’re not gonna get paid your money back? Well, since you’re buying some ownership of the company, it also means that’ll also get to share in its profits. This is known as dividend payments. Dividend payments are often paid out to investors regularly from profits or financial reserves of the company. Warren Buffet, for example, owns 36.8% of his company, Berkshire Hathaway. Essentially, this means that he gets 36.8% of dividend payments. However, in practice, Berkshire actually doesn’t pay dividends — Mr. Buffet believes it’s not yet the right time for that. So dividends can be quite a tricky thing — you may or may not get paid dividends from the stocks you invest in.
On the Ghanaian stock exchange, one hot stock in terms of dividend payments is Standard Chartered Bank (SCB). Mrs. Nettey and her team at the helms of SCB are doing a very good job with the firm. I’m gonna have to breach the rules of consistency and communicate this in Ghanaian Cedis: Dividends per share for SCB as at YE 2016 was [unsurprisingly] GHc1.12 as stated in the company’s 2016 annual report. So, a 0.8% stake in the company (roughly 2 million shares with SCB) would have earned you GHc2,240,000.00 in dividend payments in 2016. I also have to say that those 2 million shares are worth a GHc69,150,000.00 today — which is about half its share price in 2007 and a quarter of its price during the interesting 2013 recession saga. If you’d bought SCB shares in November 2013, that would have been really super. The current SCB stock price is totally worth it at 0.8% ownership.
So dividends are quite tricky. The stocks I own churn out so little each year — for now. The good thing about stocks is that they carry value. Hence, they can be exchanged for money as and when you want. So, aside from dividend payments, another way you can profit from an IPO is by selling the shares at a later date and profit from the rise in price — assuming the share price rises instead of plummeting of course.
Amazon.com, Inc, for example, had its IPO in 1997 at about $18 a share. As at yesterday, its share price was $1,586.50. However, the company had what we call a stock split. A stock split is when a stock , well, splits…lol. So that means that one share can now become 2 shares. Think of it as exchanging a $10 note for two $5 dollar notes. You retain the same value but the quantity is now different. Amazon has had quite a total of 3 stock splits between its IPO in 1997 and 2000 resulting in a cumulative 12 for 1 stock split. Essentially, this means that if you bought one share at Amazon’s IPO, you now have 12. And so the value of one share at Amazon’s IPO in 1997 is now…wait for it: $1586.50*12 = $19038.00. That’s way over 1000 times your initial investment. So if you had invested $1800.00 into Amazon’s IPO in ’97 and held on to them, you could sell those shares for a whopping $1, 800,000.00 today. And that, my friend, is why you should care about IPOs.
LB, was this elaborate enough?
Update (May 2018): Folks, the identity of LB is on a need to know basis. All attempts to find out will fail. Nerdcon, I did not write this story for my load balancer…lol!
Update (June 2018): If you liked this article, please clap for me. Not literally — it’s a thing here on Medium. I don’t write so frequently these days so the appreciation helps me know that you love this and want to see more of these. I’ve gotten really nice feedback and some people want me to write about MTN’s IPO itself. I think I’ll consider it. Thanks!
