What is IPO?

What is IPO?

Initial Public Offering (IPO) refers to the process where private companies sell their shares to the public to raise equity capital from the public investors. The process of IPO transforms a privately-held company into a public company.

 This process also creates an opportunity for smart investors to earn a handsome return on their investments.

Investing in IPOs can be a smart move if you are an informed investor. But not every new IPO is a great opportunity. Benefits and risks go hand-in-hand. Before you join the bandwagon, it is important to understand the basics.

Types of IPO

There are two common types of IPO. They are-

1) Fixed Price Offering

Fixed Price IPO can be referred to as the issue price that some companies set for the initial sale of their shares. The investors come to know about the price of the stocks that the company decides to make public. 

The demand for the stocks in the market can be known once the issue is closed. If the investors partake in this IPO, they must ensure that they pay the full price of the shares when making the application.  

2) Book Building Offering

In the case of book building,  the company initiating an IPO offers a 20% price band on the stocks to the investors. Interested investors bid on the shares before the final price is decided. Here, the investors need to specify the number of shares they intend to buy and the amount they are willing to pay per share. 

The lowest share price is referred to as floor price and the highest stock price is known as cap price. The ultimate decision regarding the price of the shares is determined by investors’ bids.

IPO Advantages and Disadvantages

Investing in IPOs comes with both merits and demerits. Here are a few of the benefits and drawbacks you must know before making your investment decision.

Benefits of Investing in an IPO

Investing in an initial public offering withholds the below-mentioned advantages-

Increased Recognition

When weighing the advantages and cons of an IPO, this good factor comes out on top. It assists management in gaining more reputation and credibility by becoming a trustworthy organization.

Companies that are publicly traded are typically more well-known than their private competitors. In addition, a successful process attracts media attention in the financial sector.

Access to Capital

A corporation may never receive more capital than it raises by going public. A company's growth trajectory might be substantially altered by the substantial cash available. An ambitious company may enter a new period of financial stability following its IPO.

This decision can help R&D, hire new employees, establish facilities, pay off debt, finance capital expenditures, and purchase new technologies, among other things.

Diversification Opportunity

When a corporation becomes public, its shares are traded on an exchange amongst investors. This increases investor diversity because no single investor owns a majority of the company's outstanding stock. As a result, purchasing stock in a publicly listed company can help diversify investment portfolios.

Management Discipline

Going public encourages managers to prioritize profitability over other objectives, such as growth or expansion. It also makes contact with shareholders easier because they can't hide their issues.

Third-Party Perspective

When a company goes public, it gains an independent perspective on its business model, marketing strategy, and other factors that could hinder it from becoming profitable.

Disadvantages of Investing in IPO

There are a few factors an investor would have to consider before starting to invest in an IPO-

More Costs

IPOs can be quite costly. Aside from the continuous costs of regulatory compliance for public firms, the IPO transaction process necessitates the investment of capital in an underwriter, an investment bank, and an advertiser to ensure that everything runs well.

Lesser Autonomy

Public companies are led by a board of directors, which reports directly to shareholders rather than the CEO or president. Even if the board delegated authority to a management team to oversee day-to-day business operations, the board retains the final say and the authority to fire CEOs, including those who founded the company.

Some businesses circumvent this by going public in a way that grants its founder veto power.

Extra Pressure

In the midst of market turmoil, publicly traded firms are under enormous pressure to keep their stock values high. Executives may be unable to make hazardous decisions if the stock price suffers as a result. This occasionally foregoes long-term planning in favor of immediate gratification.

Terms Associated with IPO

Issuer

An issuer can be the company or the firm that wants to issue shares in the secondary market to finance its operations.

Underwriter

An underwriter can be a banker, financial institution, merchant banker, or a broker. It assists the company to underwrite their stocks.

The underwriters also commit that they will subscribe to the balance shares if the stocks offered at IPO are not picked by the investors.

Fixed Price IPO

Fixed Price IPO can be referred to as the issue price that some companies set for the initial sale of their shares. 

Price Band

A price band can be defined as a value-setting method where a seller offers an upper and lower cost limit, the range within which the interested buyers can place their bids.

The range of the price band guides the buyers. 

Draft Red Herring Prospectus (DRHP)

The DRHP is the document that makes the public know about the company’s IPO listings after the approval made by SEBI.

Under Subscription

Under Subscription takes place when the number of securities applied for is less than the number of shares made available to the public.

Oversubscription

Oversubscription is when the number of shares offered to the public is less than the number of shares applied for.   

Green Shoe Option

It refers to an over-allotment option. It is an underwriting agreement that permits the underwriter to sell more shares than initially planned by the company. It happens when the demand for a share is seen higher than expected.

Book Building

Book building is the process by which an underwriter or a merchant banker tries to determine the price at which the IPO will be offered.

A book is made by the underwriter, where he submits the bids made by the institutional investors and fund managers for the number of shares and the price they are willing to pay. 

Flipping

Flipping is the practice of reselling an IPO stock in the first few days to earn a quick profit.

Any individual who is an adult and is capable of entering into a legal contract can serve the eligibility norms to apply in the IPO of a company.  However, there are some other inevitable norms an investor needs to meet.

The eligibility criteria are-

It is required that the investor interested in buying a share in an IPO has a PAN card issued by the Income Tax department of the country.

One also needs to have a valid demat account. 

It is not required to have a trading account, a Demat account serves the purpose. However, in case an investor sells the stocks on listings, he will need a trading account. 

It is often advised to open a trading account along with the Demat account when an investor is looking forward to investing in an IPO