An IPO, or Initial Public Offering, auction is an Internet-based method of opening up initial company stock offerings to the general public instead of first to institutional and large investors. It has lower costs than a traditional IPO for the company, but also has a likelihood of resulting in a lower share price on the first few days of trading than a traditional IPO. Benefits of an IPO auction for the average investor are that they allow modest investors to get in on the ground floor of many companies that they would not otherwise be allowed to buy into right away. The potential investor can also get the stock at a price that is much closer to the actual, true market value for it on the first day of trading.
Though the IPO auction method for an initial public offering sounds innovative and of great potential benefit to the average investor, the idea has been around since at least the 1980s and it has been tried in over 20 different nations and then abandoned. Certain big success stories that should have promoted the idea of the IPO auction, such as the one conducted by Google in 2004, have not succeeded in driving standard IPO filings to this format. Reasons for this are likely that the IPO auction format attracts a large number of novice bidders online who introduce unpredictable variables into the outcome of the auction, which can be detrimental to the IPO company involved.
Reasons for an IPO auction are sound, however, and may eventually give them the upper hand over a traditional IPO offering. Both standard IPOs and auctions require the management of an investment bank to oversee the process and underwrite the cost. Together the bank and the company research the market and determine what they believe to be a fair market value is for the stock before an IPO auction takes place. From this and figures on how much capital the company needs to raise, they set a level at how many shares will be sold and at what price. The advantage an IPO auction has at this point is that it has all the security of a traditional IPO, yet the costs to the company that the investment bank can charge are much lower for an online auction.
Standard IPOs require what is known as a road show, where the bank and company must directly offer the stock to large investment firms, such as hedge funds or wealthy individual investors. This takes time and coordination as to how many shares each group will commit to buying. The company must also offer the stock at a discounted value to attract these large, early investors, so it results in less capital being raised for company growth.
Modifications to the IPO auction format to make it more stable and attractive to companies considering going public include the OpenIPO version of the idea. With an OpenIPO auction, the final price of shares is not determined in a competitive bidding process online as occurs with a standard IPO auction, but is instead set at a predetermined price per share. Bidding still occurs to determine who is awarded shares, with the new approach being closely modeled on how US Treasury bills are auctioned. The new OpenIPO method has been used to launch several large companies, and may be a successful hybrid model for the IPO of the future.