When a company wants capital for growth, it may plan for an Initial Public Offering, popularly known as an IPO. When a company first goes public, its first issue of shares to the public is called an Initial Public Offering (IPO).
In an IPO, a company offers shares in the company to raise capital in the larger public market. The key benefit of an IPO is that it could raise a substantial amount of capital and, at the same time, may create publicity for the issuing company.
While the IPO provides a source of new capital, establishing the company’s value in the market and increasing its stock’s liquidity, going public can be both expensive and time-consuming. There are flotation costs such as filing fees, attorneys’ and accountants’ fees, and the underwriting fees to be paid. In addition, the costs of complying with the regulatory requirements for the IPO and continued reporting after issuance may be burdensome to the company.
In addition, as a result of the IPO, more information about the company will be available to the public. Furthermore, the original owners may be ceding their sole authority in operating the company to a board of directors. As a result, they will be subject to market pressures for earnings growth for the first time. And if the management wants the stock to be listed on a stock exchange, it must meet the requirements of the stock exchange for listing, apply to the exchange, and pay a fee.
Do you know that the capital raised by an IPO process is also risk capital?
A unique concept in an IPO is that while capital is raised, its assets are not hypothecated or burdened, as in the case of issuing debt securities.
What are the advantages to investors in an IPO?
An IPO is a winning deal for both a company and investors. Many investors do due diligence before subscribing to an IPO to know about a company. Some investors know about the company from other sources like research reports, media briefings, etc.
This helps investors to know about the company’s business and other important information that otherwise might not be available in a normal situation. In addition, investors may diversify their investment portfolio by subscribing to an IPO.
Over the period, it has been observed that IPO has helped many investors in creating wealth over a more extended period. For example, years back, those who invested in the IPO of companies like TCS, Wipro, Reliance, Bajaj, etc., made tremendous gains and created wealth.
However, it is essential that shares of these companies should have been retained for an extended period. This is because extraordinary returns from these shares in capital gains represent one of the most exciting ways of returns in the financial markets.
However, not all IPOs have led to such success stories. It is very much possible that a company may not perform as per the expectations after an IPO. Examples of such companies could be seen at any time where a company after an IPO has not been able to continue the performance as was expected from it and its share price fell after some time of an IPO.
Often a bubble is created by a particular type of industry, like a dot-com bubble, internet bubble, or something similar. It should be remembered that an IPO is just a process of raising funds from the public and listing shares at an exchange.
A company’s performance over a reasonably long period would help in valuing the shares of that company at a higher price and not just the IPO process.
What are the different stages in an IPO?
There are three broad stages in an IPO process:
In this stage, the issuing company and the critical management decisions on the requirement of raising capital through the IPO. This involves careful consideration of the pros and cons of a public offer from the company’s perspective.
It is an essential document prepared in consultation with professionals like bankers, investment banks, lawyers, accountants, legal experts, etc. A prospectus is then filed with the capital market regulator of the country. For example, a prospectus must be filed with the SEBI in India, strictly following prescribed procedures and risk disclosure regulations covering new issues.
The successful sale of shares, also known as IPO subscription, is managed by an investment bank or a group of such banks known as a syndicate. In this process, a lead bank is primarily responsible for the overall activities related to an IPO. Other participating banks in the syndicate assist in selling the securities to the investors.
Role of an Underwriter in an IPO
In an IPO, significant activity is performed by an underwriter. Usually, an investment bank plays the role of an underwriter. The primary function of an underwriter is to provide the required infrastructure. In addition, it facilitates the sale of shares in an IPO.
An underwriter helps in bringing the buyers for the IPO shares. These buyers may include both retail and institutional participants. The responsibility of a lead underwriter doesn’t stop at the successful initial subscription. Still, it extends to ensuring that the list price does not fall below the offering price after listing shares at an exchange. The offering price is when an IPO is available for purchase. A book-building process usually decides the final price of an IPO.
An IPO usually offers a defined number of shares, called the base number. However, if required, the issuing company may increase the shares it had initially planned to issue. The process of increasing the number of shares is termed a greenshoe option.
Summary: IPO; A Complex Process in Raising Capital
Issuing new securities on the market can be summarized in a few steps. Once the decision to go public through an IPO is made, the company hires a lead underwriter. That lead underwriter works to establish a syndicate of fellow investment banks that want to be involved in sharing the risk and reward of a new securities issue.
The lead underwriter and the company work together to register with the capital market regulator, like SEBI In India. Once the company receives approval, they pick a date to issue the security and start building excitement with potential investors. When that day comes, the exact amount and issue price are determined, the syndicate pays the company, and it can start selling its shares on the open market. Every individual, company, financial institution, fund house, pension fund, and all interested entities will begin participating in the IPO.