Thought of the Week / August 6, 2020
You have likely seen Robinhood Markets Inc (Robinhood) in the headlines a few times over the past few years. Robinhood is an American-based, online brokerage company with an investing app that offers commission-free trading. In January 2020, Robinhood was in hot water after it decided to hault trades for Gamestop, citing regulatory requirements. On July 28, 2021, Robinhood hit headlines when it sold shares in its IPO at $38 per share under the ticker symbol “HOOD.” The next day the company went public on the Nasdaq raising close to $2 billion.
What is an Initial Public Offering (IPO)? An IPO is when a previously private company issues shares of common stock to raise capital to fund expansion. Going public refers to a private company’s first, or “initial,” public offering (IPO) thus becoming a publicly-traded and owned entity.
Why would a company decide to do this? When a company makes money through offering common stock, they do not have to pay interest that they would have if they made this money through issuance of debt. However, there is also a downside to going public: dilution of ownership.
For example, if you or I owned a business and needed $2 Million to expand operations, we would have two choices: Option #1 – Go to the bank and get a $2 Million loan at ~5%. If our return on investment is greater than 5%, then we will have no problem servicing these debt payments. Option #2 – We bring on two additional owners, and now instead of you and I splitting profits 50/50 it is now 25/25/25/25. The benefit is that we don’t have to pay interest on the capital we raised; however, adding additional owners means our piece of the pie gets smaller.
If you are interested in investing in an IPO be sure to do your research and tread lightly. They are not all bad, as there is a significant upside for growth; however, the downside is that they are known to be extremely volatile. Be sure to do your homework and not get caught up in the hype.
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