What is IPO? – Initial Public Offering

What is an IPO - Initial Public Offering

What is IPO? It is the initial proposal of a private company that becomes public. The Company’s first equity issue is made available to the public. This is the most essential period for private investors to completely understand gains from their investment.

The transition from a private to public is also referred to as “Unseasoned new issue” or “going public”. In simple, IPO is nothing but when a company issues its shares to the general public for the first time

A few basic key terms to recognize throughout that one comes to know about the process:

  • Investor / Individual Investor: An individual with intentions of investing in public offerings, which is also referred to as “Retail Investor”.
  • Issuer: The Company that is issuing shares of stock to the public.
  • Underwriter: It referred to an investment bank that works with the Issuer to take it public.
  • Prospectus: A legal document that contains the detailed statement about the IssuerCompany’s securities and its offerings, which is required by and filled by SEC (Securities and Exchange Commission)
  • Fixed Price IPO: The price is set by the companies at the initial stage of issuing their shares.
  • Price Band: It referred to “setting value”, whereas the issuer offers the price limit from the Upper limit and lower limit, and the buyer can place their bids.
  • Under subscription: It applies when the number of securities applied for is less than the number of shares made available to the public.
  • Oversubscription: It refers to when the number of shares offered to the public is less than the number of shares applied for.

 

Why do companies go public? 

 

Establishing a new business or expanding the existing one is the common purpose behind the IPO. Primarily all companies prefer to go public because they need more money for expanding the business.

Once those companies go public, they will have greater and easier access to capital in the future. IPOs are used to finance acquisitions. This can be referred as,

  • New capital
  • Future capital
  • Mergers and acquisitions

 

How an IPO works?

 

  • A private company decides to sell its shares to the investors and fixes the price of the shares and the number of shares they ready to sell.
  • The shares of the company they offered will be allowed to get applied by the investors. Usually, IPOs get more applications for the fixed shares than the total available offer.
  • Whenever the applications are more than the offer, companies make partial allotments to investors.

 

IPO Process:

The 5 steps of the IPO process:

  • Selection of an investment bank
  • Due diligence and filings
  • Valuation
  • Stabilization
  • Transition to market competition.

 

  1. Selecting an investment bank is the first step in the IPO process. There are certain criteria to select the investment bank, which are:
  • Reputation
  • Research quality
  • Industry expertise
  • Distribution,
  • Prior relationship with the investment bank
  1. Due diligence and filings: In this process, an investment bank acts as a broker between the issuing company and the investing public. The following arrangements are considered by the issuing company:
  • Firm Commitment
  • Best Efforts Agreement
  • All or None Agreement
  • Syndicate of Underwriters

 

  1. Valuation or Pricing is the third step in this process. Here, the issuing company and the underwriter decide the price at which the shares will be sold by the issuing company. Some factors that may affect the offering price, that is listed below:
  • The success/failure of the roadshows
  • The goal of the company
  • Market economy’s Condition
  1. Stabilization: Once the deal is priced, the syndicate team of the banks will allocate shares to investors. Then the allocated shares are transferred to the investor’s Demat account. The shares after having been allotted have to be listed on the stock market.
  2. Transition: SEBI guidelines provide that the issuer in consultation with Investment Banker shall decide the issue price. On that basis, disclosures are required to be provided by both the company and the Investment Banker.

 

Types of IPO:

There are three common types of IPO. They are:

  • Fixed Price Method
  • Book Building Method
  • Combination Method

 

  1. Fixed Price Method:

In this method, the price at which the securities are offered is fixed in advance.

  1. Book Building Method:

In this method, the investors have to bid for shares within a price band specified by the issuer, and the strike price is decided after observing the result of the bidding.

  1. Combination Method:

In this method, components of both the methods- fixed price & book building method are considered.

 

How to invest in an IPO?

 

The following steps ensure that the investors are following the right way:

Decision:

With the help of the prospectus, the investors can have an idea about the company’s business plan and its purpose for raising stocks in the market, through which they can make decisions.

Funding:

Once the investor decides to invest, he/she should make arrangements for the necessary funding.

Opening trading account:

An investor who applies for an IPO must possess a Demat account.

Application process:

After creating the Demat-cum-trading account, he/she needs to know about the Application Supported by Blocked Account (ASBA) facility which is mandatory for every IPO applicant.

Bidding:

According to the lot size quoted in the company’s prospectus, investors need to bid.

Allotment:

After bidding, the process of allotment of shares in IPO begins. We cannot bid for any number of shares; the company that is issuing IPO decides the lot size. Once allotted, the shares are credited to the investor’s Demat account.

After completing the above steps, the investor needs to wait for few days to get a listing.

 

Advantages of IPO:

  • Enlarging and diversifying equity base
  • Going Public increases the Capital
  • Better rates when issued debt
  • Enabling cheaper access to capital
  • Increasing exposure, prestige, and public image
  • Can issue more stock
  • Facilitating acquisitions (potentially in return for shares of stock)

Disadvantages of IPO:

  • Loss of control over Company
  • Reporting responsibilities
  • The requirement to disclose financial and business information
  • Managing investor is time-consuming
  • Market-determined price may not reflect the true value
  • Expensive
  • Lack of Privacy

Conclusion:

 

  • As IPO is the effective way of getting funds from the public for the first time for every company which wants to go public, that company has to follow a certain set of guidelines which we call Disclosure and Investor Protection (DIP) guidelines.
  • IPO is one of the forms of raising capital and which is the effective one though it has defects.
  • Listing is important for the company on the stock exchange, so it has to be done with proper pricing.
  • From this article, you may get a clear framework about IPO. To get personal financial planning advice and goal-based investment planning, join us.

 

Leave a Comment

Your email address will not be published. Required fields are marked *