What is an IPO?

Initial Public Offering (IPO) is a process to raise money through a stake sale by existing shareholders by listing a company on a new stock exchange. It’s named IPO as it’s the first time a company is raising money through public forum though a particular stock exchange. The company, when private, usually depends on private funding from investors such as founders, friends, family, angel investors, and venture capitalists. Although private markets provide growth funding to budding companies, the ultimate exit of private investors is public markets.

IPO is one of the funding sources of equity for a business. An Enterprise’s decision to go public is partly driven by the need for funding, and to attain a potential premium value to its assets, business model and future growth.

Markets refer to this potential premium or discount as multiples because share prices of companies often trade in multiples of their underlying assets or profits. But many companies also trade below the perceived value of their assets and profit.

A listing provides private investors with an exit route mostly at a premium, while founders also get paid if they sell a part of their stake. IPO funding is primarily used by the company to fund growth, repay debt, capital investment etc.

IPO is a stock market launch of a company wherein shares are sold to retail investors as well as institutional investors. The process gives an opportunity to investors to assess and maybe take exposure in the potential growth of a business.

Returns and risks come hand in hand, and it becomes imperative for investors to carefully evaluate the opportunity compared to the offering price of the securities. Not all IPOs end-up becoming a large-cap company, therefore it is essential to assess the associated risks.

Please note: a company which is offering its shares to be public is not obliged to repay the capital invested by the public investors.

What is the process of an IPO?

Not every company is fortunate enough to sail through an IPO process. Going Public is a big step for a private company, which means that the company can now have access to a lot of money, giving it a better opportunity to grow and expand. Further, meeting disclosure criteria and share listing credibility can be used to negotiate for better terms in case of borrowed funds. And even after making into stock exchange bourse, there is no guarantee that the company will have a share price growth over the future.

IPO process is complex and requires time, money, and substantial consulting. While investment bankers are inclined to take most of the companies’ public, it solely depends on the perception of public markets of the upcoming listing.

Selecting an Investment bank: As step one, a company which wants its transformation to a public goes to investment bankers, for advice on the transaction and to provide underwriting services.

Investment banks evaluate the prospects of a business and its past performance. They also look carefully at the business model, industry, and products of the company. An IPO prospectus includes a lot of information about the business that is mostly sufficient to evaluate an investment opportunity.

Companies often select banks that have been engaged with the business in the past because these banks know in and out of the company. Other factors that impact the selection of a bank include the reputation of the bank, the ability to deliver quality research, and underwriting capability.

Regulatory filings: Markets regulators regulate public markets across most of the jurisdictions. Since public markets come in the ambit of market regulators, IPOs are also monitored and evaluated by the regulators.

This process also includes completing the underwriting agreement with the investment bank. Underwriter effectively acts as a broker between public market investors and the company. The investment bank or group of investment banks decide their underwriting capacity.

In this stage, the company also provides necessary information and disclosure to the stock exchange and market regulator. It also registers the prospectus prepared by an investment bank. An IPO prospectus is an extensive document about the company’s business model, business fundamentals, management background, as well as legal information related to the IPO.

Once the prospectus is registered, it is accessed by investors who are willing to invest in the upcoming IPO. Therefore, the prospectus of the company provides a base for investment decision-making of investors.

Pricing of the IPO: After the necessary fillings and approvals, the investment banks that are handling the transaction undertake pricing of the company. The offer price of an IPO is based on valuation, market factors, and business performance.

IPOs are priced in two ways. In a fixed price offer, the offer price of the shares is fixed by the investment bank based on the valuation; this process is usually applied when a small company is going public.

In the book-building process, the investors submit their bids to the investment banks promoting the IPO transaction. This process is used for a large enterprise to obtain a maximum issue price for the stock based on the investors’ expectations. Once investment bankers receive bids, they evaluate the bids provided by investors and arrive at an issue price for the company’s share.

Offer period: After the pricing of the IPO is completed, the offer period commences, which is given in the prospectus. During the offer period, the public market investors subscribe to the IPO of the company.

This period usually decides whether the IPO is ready to hit the market or not. A company should achieve a minimum subscription to make debut in the markets. And the underwriting facility provided by investment banks seeks to ensure that minimum subscription is met.

Allotment of shares: Once the offer period is closed, it is revealed whether the IPOs was oversubscribed or undersubscribed. If the issue is undersubscribed, the investors will receive the same number of shares subscribed by them. When shares are oversubscribed, the underwriters have the option to raise the price, offer additional securities or consider both.

Advantages of IPO

Primary objective is to raise money for a business. Whereas other benefits include:

• Facilitates completing acquisition deals, by helping in determining acquisition pricing and paying by issuing shares.
• Necessary transparency measures help in favourable terms of borrowing.
• Further funds can be raised through public, by going in for secondary offerings.
• Expands the company reach for money, its prestige, and improves its public image.

Disadvantages

• IPO is a very expensive process and requires a lot of work. It not only needs expert services of investment bankers to be listed, but the cost of maintaining a public company is ongoing.
• The focus of the company management may change; a lot of effort goes under disclosing information.
• Original shareholders lose control of the company due to new shareholders obtaining voting rights.
• Sometimes practices inflating the share price of the company are used, which increases the risk and instability of the company.