An IPO (Initial Public Offering) is the process of selling shares of a private corporation to the general public in a new stock issuance. An IPO allows a company to raise capital from public investors. The transition from a private to a public company can be an important time for private investors to fully realise gains from their investment because it typically includes a share premium for current private investors. Meanwhile, it allows public investors to participate in the offering.
About IPO (Initial Public Offering)
The capital market is made up of the “Primary Market” and the “Secondary Market.” The capital market is divided into two interdependent and inseparable segments: new issuers (primary market) and stock market (secondary market). Issuers use the primary market to raise new capital from investors through initial public offerings, rights offerings, or offers to sell equity or debt. An active secondary market encourages primary market growth and capital formation by assuring primary market investors of a continuous market in which to liquidate their investments.
A company may raise capital in the primary market through an initial public offering, rights offering, or private placement. An initial public offering (IPO) is the sale of securities to the general public in the primary market. It is the company’s largest source of funds with a long or indefinite maturity.
An IPO is a critical step in the growth of a company. It allows a company to raise funds through the public capital market. An IPO also significantly boosts a company’s credibility and publicity. An IPO is often the only way to finance rapid growth and expansion. When a large number of IPOs are issued, it indicates a healthy stock market and economy.
When a company goes public for the first time, the relationship is direct between the company and the investors, and the money flows to the company as “Share Capital.” As a result of their participation in the Company’s IPO, shareholders become owners of the company and have ownership rights over it. This is the most significant source of funds for a company, allowing it to create “Fixed Assets” that will be used in the course of the business. The Company’s shareholders have the option to sell their shares on the secondary market.
WHY IPO s (Initial Public Offering) ?
Corporates opt for IPO for basically their two types of needs:-
1.For Funding Needs
- Funding Capital Requirements for Organic Growth
- Funding Global Requirements
- Funding Joint Venture and Collaborations needs
- Funding Infrastructure Requirements, Marketing Initiatives and Distribution Channels
- Financing Working Capital Requirements
- Funding General Corporate Purposes
- Investing in businesses through other companies
- Repaying debt to strengthen the Balance Sheet
- Meeting Issue Expenses
2. For Non-funding Needs
- Enhancing Corporate Stature
- Retention and incentive for Employees through stock options
- Provide liquidity to the shareholders
How an Initial Public Offering (IPO) Works ?
A corporation is deemed private prior to an IPO. As a pre-IPO private company, the company has grown with a small number of shareholders, including early investors such as the founders, family, and friends, as well as professional investors such as venture capitalists or angel investors.
An IPO is a significant milestone for a company since it allows it to raise a large sum of money. This increases the company’s ability to grow and expand. The enhanced openness and share listing legitimacy may also aid in obtaining better terms when seeking borrowed capital.
A company will start to publicise its interest in going public when it reaches a point in its growth process where it believes it is mature enough for the obligations of Securities and Exchange boards laws as well as the advantages and commitments to public shareholders.
This stage of development often starts when a business achieves unicorn status, or a private valuation of about $1 billion. However, depending on the market competition and their capacity to meet listing standards, private companies at varying values with sound fundamentals and demonstrated profitability potential may also be eligible for an IPO.
A company’s IPO shares are valued via underwriting due diligence. When a corporation goes public, the privately held shares then, transforms to publicly held shares, and the shares of the existing private shareholders are now worth the public market price. Special terms for private to public share ownership may also be included in the share underwriting.
In the meantime, the public market creates a significant opportunity for millions of investors to purchase firm shares and add money to the shareholders’ equity of a company. Individual, group, firm etc investing in the company, are the investor of the public company.
The factors that create the majority of the company’s new shareholders’ equity value are the volume of shares sold and the price at which shares are sold. When a company is both private and public, shareholders’ equity still refers to the shares that investors possess, but with an IPO, the shareholders’ equity rises dramatically thanks to the funds raised from the primary issuance.
Investing in an IPO
A company will only opt to raise funds through an IPO after giving it serious thought and study to see whether this specific exit plan would maximise the rewards for early investors and generate the most money for the business. As a result, there are likely to be many public investors waiting in line to purchase shares for the first time when the decision to launch the IPO is announced. IPOs are sometimes discounted to encourage sales, which increases their allure, particularly when they draw lots of buyers from the initial/primary issuance.
Initially, the underwriters determines the price of the IPO through their pre-marketing process. The IPO price is fundamentally dependent on the company’s valuation, utilising fundamental methodologies.
The most common technique used is discounted cash flow, which is the net present value of the company’s expected future cash flows.
Underwriters and interested investors consider this value on a per-share basis. Other price-determining approaches include equity value, enterprise value, comparable firm adjustments, and others. Underwriters take demand into consideration, but they also often lower the price to ensure success on IPO day.
Points to be considered by an investors before investing in an IPO.
- Analyzing the fundamentals and technicals of an IPO issuance can be complex. Investors will pay attention to news headlines, but the prospectus, which will be available as soon as the firm files its S-1 Registration, should be the primary source of information. The prospectus contains a wealth of important information.
- Investors should pay close attention to the management team and their commentary.
- Investors should pay close attention to the underwriters’ quality and the terms of the transaction. Large investment banks that can effectively promote a new issue will often support successful IPOs.
Performance of an IPO
There are several factors that influence the return on an IPO, and is often closely tracked by investors. Investment banks may overhype some IPOs, resulting in early losses. However, when they are made public, the most of of IPOs are known to gain from short-term trading. A few significant factors influence IPO performance.
If you look at the charts following many IPOs, you’ll see that the stock drops significantly after a few months. This is frequently due to the expiration of the lock-up period. When a business goes public, underwriters require insiders such as officials and workers to sign a lock-up agreement.
Lock-up agreements are legally enforceable arrangements between the company’s underwriters and insiders that limit them from selling any shares of stock for a set period of time. The duration might range from three to twenty-four months. The issue is that when lockups expire, all insiders are free to sell their stock. As a result, there is a rush of investors attempting to sell their stock in order to realise their profit. This surplus supply can put significant downward pressure on stock prices.
In the terms of their offerings, certain investment banks impose waiting periods. This reserves a certain number of shares for purchase at a later time. If the underwriters decide not to purchase this allocation, the price could drop.
The act of “flipping” involves reselling an IPO shares within a short period of time in order to make a quick profit. It frequently happens when a stock is discounted and then surges on its first trading day.
What Is the Purpose of an Initial Public Offering (IPO)?
Large corporations typically utilise IPOs as a means of obtaining money by selling their shares to the general public for the first time. Shares of the company are traded on a stock exchange after an IPO. One of the major reasons for doing an IPO is to raise money through the sale of shares, to give firm founders and early investors liquidity, and to reap from a higher valuation.
Can Anybody Invest in an IPO?
For a new IPO, there will frequently be greater demand than there is supply. Because of this, there is no assurance that all potential investors in an IPO will be able to buy shares. While entry to an IPO may occasionally be restricted to a firm’s larger clients, those interested in taking part may be able to do so through their brokerage firm. A mutual fund or other investment instrument that concentrates on initial public offerings provides an additional choice.
Is It Good to Buy IPO Shares?
Frequently asked questions about IPO (Initial Public Offering)
What is Gmp In IPO?
he difference between the initial public offering (IPO) price of newly issued securities or commodities and the price of those same securities on a stock exchange or other freely accessible trading venue is known as the grey market premium. Read more about GMP
What is over subscription in IPO?
Oversubscription occurs when more shares in an IPO are requested than are actually available. The phenomenon happens when people are so eager to invest in a new business that they give more cash than the business needs or is willing to accept. Read More about Over subscription in IPO
What is the full form of IPO?
The full form of IPO is Initial Public Offering