Definition: An Initial Public Offering (IPO) can be stated as a means of generating capital for a private company by publicly issuing its stock for the first time. Later, these securities can be traded after being listed over the stock exchange.
An IPO is also acknowledged as ‘going public’ or ‘float’. A small company looking forward to reaching a new horizon acquires capital from the float issuance.
The initial public offering has even secured a place in the portfolio investment of many High Net Worth Investors, whether individuals or firms.
Content: Initial Public Offering (IPO)
- IPO Process
- Types
- Advantages
- Disadvantages
- Investing in IPO
- How to invest in an IPO?
- Key Points to Acknowledge Before Applying for a Float
- Example
Initial Public Offering Process
Small enterprises mostly presume that going public is a hefty procedure and they won’t be able to actualize it. Given below is a systematic nine steps method of issuing the float:
- The various investment banks approach the company with alluring offers, seeking the opportunity of underwriting the corporate stocks.
- One or more suitable underwriters are selected and the company enters into an underwriting agreement where both the parties abide by the terms of each other.
- Specialized people are assembled into a team, including SEC experts, lawyers, underwriters and certified public accountants.
- Next, the essential data which facilitates the IPO documentation is brought together by the management.
- The company plans for the promotion of the new stock release and determines a favourable offering price on the grounds of public demand.
- Finalizing the board members is equally important to facilitate top-level decision-making.
- Monthly, quarterly and yearly finance and accounting reports are prepared and presented.
- The company then releases the float on the pre-determined IPO date.
- Further, the after IPO provisions such as buying of additional shares post-IPO date by the underwriters are enacted.
Types of IPO
For an organization, there can be multiple ways of going public. Lets unfold the different kinds of float offering one by one:
Fixed Price Offering: In such a float ensure the company presumes an issue price which is disclosed to the investors beforehand. Thus, the investors need to pay the full amount at once during the application process.
Book Building Offering: This IPO is priced based on the investor’s bid. The float is available at a 20% price band payable at the time of application. The investors need to price the shares along with their requirement, the highest bid is termed as cap price and the lowest one as the floor price.
Green Shoe Option: This is an over-allotment option available with the underwriter under a provision which allows the respective underwriting firm to acquire 15% more shares at the same price. These shares can be given out to the investors in case the IPO demand shoots up.
Dutch Auction: Here the company lets the investors bid their required number of share units and the price they are willing to pay for it. These bids are arranged in the descending order until it reaches the last unit to be allotted.
IPOs are issued to the selected investors who lie in this highest bids range. The offering price is set as the lowest bid of this range i.e., at which the last allotment unit was bid. The rest of the bids are rejected.
Hybrid: This initial public offering amalgamates two or more of the above float strategies.
Advantages of IPO
Releasing float resolves the capital acquisition problem of the organization; as well as provides brand recognition to small companies. Moreover, it brings an exciting investment option for investors.
The various pros of an IPO to both, the company and the investors are mentioned below:
To the Company
- Reduces Cost of Capital: While debts bother companies with interest and liabilities, IPO reduces the burden by raising equity capital in return of corporate ownership.
- Equity Participation for Employees: Many companies have an IPO employee quota, which provides the employees with an opportunity to buy IPO at a discounted price.
- Superior Management Team: With an impressive IPO issuance, the organization can seek the attention of the top managerial talents in the industry.
- Improves Competitiveness: To beat the business rivals and grow the business, companies need debt-free funds which can be availed through IPOs.
- Initiates Merger or Acquisition: Issuing the IPO builds brand image and further gets recognition among the corporates for merger or acquisition.
- Backs Huge Projects: When the organization requires capital to support a new opportunity or project, the easiest way out is to go for initial public offering.
- Favourable Credit Borrowing Terms: IPO bounds the company to maintain transparency, thus when every information is available publicly, the credit terms also soothes.
To the Investors
- Gains from Flipping: Buying the IPO and short-selling it at an appraised value can be a profit-making deal for the investors.
- Appraisal of Investment Value: Even if the investor holds the float, its value increments over the long-term if the company emerges to be a great success.
- Price and Information Transparency: Any company going public has to make sure that it releases stock or company-related information publicly.
- Cheapest Price: For any investor, an IPO is a lifetime chance to invest in the company at a minimal cost. Since this small organization may turn into an empowered venture someday.
Disadvantages of IPO
While we discuss the reasons for issuing and buying of floats, we cannot overlook its adversities and limitations.
Some of the major cons of an IPO for the issuing company and the investors are elucidated below:
To the Company
- Loss of Control: Giving away equity stocks publicly means releasing the company’s control over its business operations.
- Public Disclosures: It becomes mandatory to revealed l the stock price and corporate information to the public, which also reaches to competitors who may use it for business rivalry.
- Expensive Affair: The company bears the cost of accounting, financing and legal process for handling a public company which is above all other expenses.
- Regulatory Problems: The stock exchange regulatory bodies keep a close look over the company’s performance and activities to safeguard the investors.
- Fluctuating Share Prices: The stock exchange listing results in a price change and generates the risk of overselling by the investors ultimately resulting in a corporate loss.
- Timing the Market: It is essential to issue the float while the market is in a stable position, thus, timing the market becomes a challenge for the team.
To the Investors
- Profit Not Guaranteed: No float opportunity promises gains; it may even deteriorate in value.
- Lack of Liquidity: Lockup period restricts the investor to sell out the stocks purchased under IPO, for a certain duration.
- Risk Prone: Like all other investments, the risk is an inseparable part of the initial public offering too.
- Volatility: The price of such stocks vary frequently. This is because the company is at its startup stage.
Investing in IPO
An investor is a party who applies for and intents to buy a company’s initial public offering. The float investors include individuals, broker firms, employees, institutions and others.
How to invest in an IPO?
A person cannot just go out to a shop and ask the seller for an IPO. right? There is a synchronized procedure for applying and acquiring the stocks issued under the float, as elaborated below:
- Explore all the available IPO option, research about the companies, thoroughly and pick a favourable float.
- Next, ascertain that you have sufficient money to apply for the initial public offering, if not, make an arrangement.
- A Demat cum trading account is the electronic address of a stock holding, so go for it. For this purpose, the investor’s identity proof, PAN card and address proof are required.
- Now, fill up the Application Supported by Blocked Account (ASBA) form by inputting details like bank account number, Demat account number, PAN card and bidding information.
- Make the bid for the IPO lots, where the lot size denotes the least numbers of units for which an investor needs to apply.
- The company assigns the shares to the applicants on the IPO date whether in full or in smaller number than they applied for (i.e., on pro-rata basis).
- The last step is to have patience till the stocks get listed for selling and purchasing on the stock market.
Key Points to Acknowledge Before Applying for a Float
Some say be careful while stepping into the stock market, others believe it to be a highly profitable idea. Well, these contrasting views can be seen as an impact of behavioral finance.
However, if we analyze an IPO, it can fetch you a handsome gain if you go about it smartly.
The following five key notes would simplify your task of selecting an IPO:
- The investor should keep in mind the period for which the invested sum would be blocked, before selecting an IPO.
- Knowing the in and outs (history and records) of an organization along with the team responsible for handling the funds is to win-win for an IPO investor.
- Be cautious with your purpose of buying the float; it can be either holding on the stock or reselling it for short-term profits.
- An underwriter’s market reputation uncovers its purpose and reason for underwriting a particular company’s stock.
- Sometimes, the company’s float price is unnecessarily upraised due to corporate reputation and after the release, the stock value slopes down; so beware.
IPO Example
One of the recognized e-commerce companies ‘Alibaba’, issued the biggest IPO priced at US$68 on September 18, 2014. Later, it got listed on the NYSE.