With all the hoopla surrounding the anticipated Facebook IPO, many people are wondering what, exactly, an IPO is. When you understand this, you have a better chance of figuring out whether or not getting in on an IPO is worth it to you. Besides, it helps to understand terms like this if you are going to bandy them about in conversation.

IPO: Basic Definition

An IPO is an initial public offering. It is basically the first time a company decides to sell stock to the public. Often, when a company decides to launch an IPO, it is said to be “going public.” The stock is no longer just offered to company owners and employees, and the company is no longer considered private. Now the public can buy shares, and anyone with the money to purchase the shares can have a degree of ownership in the company. The company is considered a public company.

Why Do Companies Have IPOs?

Companies are interested in IPOs because they offer the opportunity to raise more money. In an IPO, investors are buying shares from the company, so the money from the sales goes directly to the company. This provides the company with an infusion of capital that can be used for a variety of purposes. If a company wants to expand, an IPO can be a way to raise a large amount of capital — especially if the IPO is highly anticipated as the Facebook IPO is.

Once the IPO is over, though, the money for shares is exchanged between investors. If I buy 10 shares of Facebook stock during the IPO, the money goes to the company. However, if I decide to sell five of the shares in two months, I receive the money from the investor that buys the shares from me. Facebook doesn’t get the money anymore. In order to raise more money, Facebook would have to issue more shares, or go through a buyback and then sell those shares again later.

Should You Invest in an IPO?

Investing in an IPO is an interesting opportunity. However, you need to be aware of some of the realities of investing in an IPO. While some of documented that IPO prices are often low, they don’t always pan out to big profits for the “regular” investor. Indeed, if you think that you are going to get the Facebook IPO for an amazing deal, you might be disappointed. Insiders actually get the first crack at low initial costs set by investment bankers and the companies themselves.

In the first few hours or days of trading, a share price can skyrocket. However, they often settle down and the gains aren’t as huge as expected. Indeed, you might be disappointed when you go to sell a week or two later, only to find that the share price hasn’t moved as much as you would like. Getting the jump on a good IPO price is hard work for the average investor, and it’s even harder to determine if you will be able to see decent profits.

If you believe in the company, though, an IPO might be just the thing to help you get in on the bottom floor, and see a solid buy and hold stock.