As investors continue to look for new growth ideas, new areas for returns are always being sought after.

And many investors with a higher tolerance for risk and a desire to jump on new trends will often turn to an IPO.

An IPO is an attractive alternative for both the investor and the company.

With a successful IPO, the company gains additional funds to fuel its future growth, and investors gain a piece of a company as they move from private ownership to public shareholders.

In this article, find out the pros and cons of an IPO and whether it is a good investment.

What is an IPO

An initial public offering (IPO) is when a private company first makes its shares available to the public. The shares are listed on a public exchange, and they can be bought and sold by investors, both institutional and everyday investors with a trading account. To invest in an IPO, individual investors can buy a number of shares from the public market as they are available.

The private company undertakes a significant effort to prepare for an IPO. They must register with the SEC, have their financials audited, file the appropriate paperwork, and then go through the process of setting a price, usually done with the help of an investment bank who has specialized knowledge in the IPO process. The process it undertakes is known as the initial public offering (IPO), where shares of company stock become available for purchase by the public. That’s why a business that issues an IPO is known as “going public.”

Going through the IPO process gives the private company access to capital that isn’t available in other forms. Going public in an IPO gives them access to a lot of money, which can be used to facilitate acquisitions, fund research projects, pay off debts, or undertake other financial endeavors. It also allows private shareholders, such as angel investors or the company’s founders, to create liquidity by monetizing their investments. IPOs provide a big boost to a company in terms of visibility, transparency, and even credibility to the public—and they could also help the company secure better terms from its lenders.

The Benefits of Buying IPO Stock

There are several benefits of buying IPO stock.

The first, and perhaps the most important one, is that you can get in early on a company if it later grows to be a giant. Getting in on the ground floor of a company almost guaranteed you’ll have gains if the company hits it big. And if a company hits a growth spurt, then your initial IPO investment could insure you’ll have huge returns in a short amount of time.

The long term gains of building up a large nest egg from an early investment are compelling. A massive return could add significant portions to your retirement fund or your individual wealth.

Lastly, the initial price of the IPO is often the cheapest price for a company. There’s always risk, even in an IPO, but if a company grows big, then you’ll be one of the early investors who maximized their investment.

The Downsides of IPO Investing

For an individual investor, the biggest downside in investing in a IPO may be the volatility. The up and down swings from price fluctuations may be a challenge for many everyday investors to stomach. It can be hard for a person to stay calm when they see portions of their money jumping widely day-to-day, hour to hour.

Many individual investors have a difficult time remaining calm during these wild up and down price swings. And when the pressure becomes too much, the new IPO investor may jump to sell instead of relying on the valuation work and due diligence performed before the investment. In other words, instead of trusting their analysis, they panic and sell their position, often at a loss.

For the individual investor, not all IPOs are fireworks, cake, and triple digit gains. Even with an early ump up in price, the realities of the market may set in and curb the growth of the company. There are plenty of examples of companies that did not live up to their IPO expectations.

For company owners and management team, there are also downsides to going public. One of the obvious changes is the degree of public disclosure required after a company goes through the IPO process.

These disclosures are part of the regulations set forth by the Securities and Exchange Commission (SEC). These disclosures are required by federal law and monitored for compliance. For a private company that has recently gone public, the cost and effort associated with complying with these regulatory requirements are often very high.

Over the years, as more regulations have been added, the costs of compliance have risen. These additional costs include the hiring of expertise and teams to handle activities related to financial reporting, auditing the documents, handling investor relations, and dealing with accounting committees.

The increase in reporting costs are combined with additional pressures of shareholders and pressures from Wall Street, who all may force the company to focus on short-term results rather than long-term growth. This short term focus may affect the decisions of the management teams as they seek out higher short-term sources of profit.

For both the individual investor and the company, there are several disadvantages to consider when going public. It is best for both parties to evaluate the advantages and disadvantages of going public to make a decision if the benefits outweigh the new costs associated with being a public company.

How to Evaluate Buying an IPO Stock

Before you decide to buy an IPO stock, be sure to check out the strengths of the business itself.

You’ll want to take into consideration several factors that define the future growth of the stock. The reason why this is important is simple – not all IPO stocks are going to go up when they are released

So before you invest, you’ll want to evaluate the chances for continued growth in whatever industry the company is operating. In your analysis, be sure to consider the competitive forces that may limit the future growth of the particular company. This should factor into your analysis as you are evaluating the industry,

Also, be sure to consider the competitive forces acting against your company. You’ll want to evaluate the advantages that this particular company has for its few future.

Lastly, when you’re evaluating the IPO stock, be sure to consider new companies coming in and competing against the company if it starts to perform well.

On a personal level, you’ll want to consider several factors as well.

Even though this is an IPO stock purchase, you will still own shares of a company and easy way to think about this is a simple evaluation if you had ownership of this company for five or 10 years, would you be happy owning it that long?

This question connects back to your earlier analysis.

Finally, as you’re deciding about buying and IPO stock and you’ve done your due diligence, consider your reaction if the stock plummets if you are still comfortable owning the stock after these scratch that line.

There are many more steps involved in due diligence and adequate analysis.

But these directions we’ll set you down the path of investigation for owning the IPO stock headline.

What should you watch out for while deciding on an IPO investment?

There are several factors to consider.

When you’re deciding on an IPO investment, the first factor to consider is the amount of risk in the stock purchase.

There is no investment that is free of risk and IPOs are no different.

In fact, some IPOs offer more volatility than other investments. So individual should be prepared to deal with the element of risk.

Despite the fact that a private company has grown to a stage where they need an IPO to grow in the future, going public does not guarantee future success for the company or for individual investors.

When making the decision to invest in an IPO, you’ll also want to consider your own risk tolerance. If you have a low appetite for risk, then you may want to consider other investment vehicles besides IPOs.

The IPO share price can be volatile as the company continues to grow.

And it’s important to keep in mind that, despite the media reporting, not every IPO ends up hitting it big.

Evaluating your personal risk profile will help guide you in deciding to invest in an IPO.

Another consideration is evaluating the management decision for raising funds with an IPO.

Investors may find the answer to this question in the company S-1, which is a public document that must be filed before the IPO process. This public document is perfect for early investors to evaluate the financial situation of the private company. Use this document to find out the reason for going public and the reason behind the management team seeking additional funds.

Also, investors should consider the future use of the funds. Verify that the company plans to use future funds for expansion and growth. If the company is using the capital raised from the IPO to pay down debt, then that might be a signal that market growth has stalled or the company is going public to avoid financial turmoil from being leveraged.

Lastly, you’ll want to consider the media frenzy and initial excitement excitement that comes along with an IPO.

IPOs have increased in awareness with everyday investors and many of them consider an IPO an exciting new vehicle for investment growth, yet very few are willing to do the homework to verify the growth potential of the firm.

When you are determining whether an IPO is right for you, be sure to do factor in the initial excitement about IPOs. Don’t get caught up in the hype cycle and invest your money in a company with poor growth prospects.

Finally, remember that initial growth does not mean long term growth. In the beginning when companies are small, it is easier to hit higher growth percentages. Over time these gains may diminish, thus driving the stock price down. Be sure to factor this behavior into your analysis.

But despite the media attention, IPOs can be volatile and may not lead to the large gains that you imagine. Before you invest, be careful to perform all of the investigation and due diligence to be comfortable with your decision.

Investing In IPOs May Be For You – But It’s Complicated

IPOs are a great investment vehicle for companies and for private investors.

They can help your portfolio expand when combined with other methods. There are plenty of opportunities to invest in solid companies who have bright futures after going through an IPO.

But plenty of IPOs do not live up to the hype, so take care.

Do your research to avoid taking any unnecessary risk.

IPOs can be a great investment, but like the other investment vehicles, you must be careful to do your own due diligence and analysis before you invest your money.