When stock markets are going through a boom phase, you’ll not stop hearing about IPOs.

But what is an IPO? Are they worth your money, or are they City scams designed to rip you off?

The answer is that just like every other investment, IPOs can be good or bad. You have to consider each IPO on its own merits.

This post will tell you what is an IPO. Future posts will look at how you can take part in an IPO, and what to look out for when investing in one.

What is an IPO?

IPO stands for Initial Public Offering. An American term that became popular during the Dotcom boom, it has pretty much replaced the old UK equivalent, ‘new issue’, and is steadily replacing the other alternative, ‘flotation’.

As the name suggests, an IPO is when a company first comes to the stock market (that’s the ‘initial public’ bit) and issues a tranche of its shares to be traded (the ‘offering’).

A company might decide to be listed for many different reasons. By far the most common are:

• Money: The company founders or backers want to realise some of their investment, by selling their shares to the public. (This is known as an ‘exit’).

• Funding: The company needs cash for expansion or takeovers, and raising it through equity is seen as a better option than taking on debt. Once listed, a company can also use its shares directly to fund takeovers.

• Encouraging staff to stay: Listing on the stock exchange creates a market for the company’s shares. With this is in place it can more credibly issue share options. Staff can later convert these into shares, to sell at a profit.

• Going broke: The company may simply need more money just to stay in business! Usually IPOs are only possible here if the company is a great prospect in an exciting growth sector like biotech or the Internet, where there’s the potential for big rewards.

Note that a company rarely lists all its shares on the stock market in one go in an IPO. Usually only some portion of the share capital becomes publicly traded, with founders and other investors (or even the company itself) retaining ownership of the rest. But once a company is listed on a stock market, it can raise more money by issuing more shares. Known as a ‘rights issue’, this gives the company further flexibility, even if it doesn’t need the money right away.

An IPO is an expensive undertaking. Banks, lawyers, and City advisers are required to facilitate an IPO, and their trophy wives / manicures don’t come cheap. As much as 10% of the money raised may go on their fees. Some pundits have scurrilously suggested that excessive banks are put on the IPO ticket just to encourage favourable coverage of the newly-listed company!

Even once the IPO bills are paid, life after flotation is more expensive for the company than before. Its accounts must be more rigorously audited, and all kinds of other regulation comes into play, as well as fees for remaining listed. There’s also greater public scrutiny, and pressure from City funds and other shareholders for a regular dividend and a rising share price.

Given these hassles, you must ask yourself what is an IPO really being undertaken for, and who will benefit? Is it merely the founders cashing out, or will being listed help the company going forward?

You don’t want to spend your money making the founders rich, but leaving you with a dud investment!

The best of the week’s money reads.

I was sad to see Steve Jobs finally throw in the towel this week on his ability to run Apple, the company he first founded and later saved.

Over the past few years, Jobs has led one of the greatest companies the world will ever see, produced peerless products (I haven’t bought a non-Apple computer since the Amiga!), fought cancer, and seemed to be having a whale of a time throughout.

There’s many lessons from Jobs’ life that I wish could inspire my day-to-day living as much as they do when I first encounter them.

But perhaps his most universally inspiring message was the simple one he gave to a class of US graduates:

“When I was 17, I read a quote that went something like: “If you live each day as if it was your last, someday you’ll most certainly be right.” It made an impression on me, and since then, for the past 33 years, I have looked in the mirror every morning and asked myself: “If today were the last day of my life, would I want to do what I am about to do today?” And whenever the answer has been “No” for too many days in a row, I know I need to change something.”

Steve Jobs is 56 and his net worth is at least $8 billion, but that hasn’t saved him from the random mutation of his cells. He is an artist who happens to have the technical foresight of Thomas Edison and the business acumen of Henry Ford. Or maybe he’s Bill Gates with an eye for colour.

He’s also a charismatic leader that can rally his people around him despite being difficult to work with, or even obnoxious.

Most importantly, Jobs can say “no, that’s not good enough” and demand a prototype is improved. Such an obsession on quality is incredibly rare. It is the difference between Apple and its rivals, and the difference between capitalist flair and bureaucracy (aka Nokia).

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Many investors seem to be confused about whether you can hold foreign shares in ISAs.

The answer is simple: You can!

According to HMRC, you can hold foreign shares in an ISA as long as the shares are in a company listed on “a recognised stock exchange anywhere in the world”.

HMRC doesn’t specify exactly what it means mean “recognised”, so you may have trouble if you want to snap up some Mongolian-listed bargains.

But shares listed on the New York Stock Exchange, NASDAQ, German companies listed on the DAX, and shares traded on the other big markets around the world are all eligible.

The same rule holds for corporate bonds issued by overseas companies.

To be clear, I’m talking about stocks and shares ISAs here, specifically the ‘self-select’ variety that enable you to buy and sell whatever shares, ETFs, bonds, or any other permitted investments you want.

Many investors choose to get overseas diversification through index or managed funds, where they buy the collective fund through the manager, and they’re fine, too. New country-specific ETFs are being launched all the time.

The only stipulation is that such a fund must be recognised by the Financial Services authority to qualify for holding in an ISA. Anything you or I need (or should) invest in will qualify.

Investing in foreign shares

There are a few other complications to be aware of when investing in overseas shares in an ISA.

Broker discretion

Your particular broker may not enable you to buy or sell overseas shares on any or all major stock exchanges, even if you are legally allowed to hold them in your ISA. Or you may need to fill in forms to do so. For instance, all the brokers I use insist I fill in a W-8BEN form to trade US stocks.

Currency risk

Buying and holding overseas shares exposes you to currency risk. This can be a positive or negative depending on how the UK pound performs, and as such it additionally diversifies your portfolio in currency terms, as well as the potential diversification you’re getting from the performance of different stock markets around the world.

Withholding tax / double taxation

Holding overseas shares exposes you to tax complications, even in an ISA. We’ve written the definitive article on withholding tax, so go check it out. The key takeaway is usually you can avoid being taxed twice if you find and fill in the correct form. For instance, the W-8BEN form allows UK investors to pay a lower rate of US tax (15% instead of 30%) on dividend income from US shares.

Higher dealing costs, but no stamp duty

Brokers usually charge you more to buy and sell overseas shares – even shares listed on very liquid markets like the NYSE. But the good news is most other territories don’t charge stamp duty when you buy shares, saving you 0.5%.

Have ISA, will travel

The big restriction for UK private investors looking to invest in shares in an ISA remains the ban on companies that trade on the AIM market.

This ban holds despite lobbying that the restriction is no longer valid, given the changes to capital gains tax treatment of AIM shares – and the fact that you can hold AIM shares in a Self-Invested Personal Pension.

But as for buying and holding foreign shares in an ISA, the world is your oyster!