How an IPO works and who can buy in to one

One of the more exciting events in the stock market is an initial public offering (IPO), especially those involving high-profile companies. IPOs give the general public the opportunity to invest in companies that may have previously accepted financing exclusively from large institutional investors, private equity firms or venture capital funds.

Typically, a company that wants to raise hundreds of millions, or even billions, of dollars through an IPO process won’t go straight to average investors. Instead, the company will team up with its bankers and advisors to pitch their company to very large institutional investors, hedge funds, and other “big players” with very deep pockets.

This process is referred to as a “roadshow” because the company and its team hit the road to visit multiple cities in a short period of time. On Monday, the company could meet with a hedge fund in Toronto with the hopes of raising $100 million. The next morning, it might have a meeting in Vancouver with representatives of a sovereign wealth fund. A large IPO could have the roadshow travel internationally to global financial hubs like New York, London and Hong Kong.

In some cases, companies launching an IPO could be very young or very unprofitable — or both. Some of those companies may not even have generated any revenue to date. An example of this scenario would be a pharmaceutical company working on finalizing a medication that's in demand in the market. That medication could not generate any revenues until (and if) it obtains regulatory approvals.

Investors are encouraged to read each company’s management disclosure on when it expects to become profitable, that is, if it isn’t already. Some companies might be one or two years away from generating a profit while others might take longer.

Some investors won’t consider investing in companies with no near-term path to profit. Other investors might jump on the opportunity if they believe shares are currently undervalued and don’t mind holding on to the stock for a few years. In addition, investors may also look to new and emerging industries.