An Initial Public Offering (IPO) is the first time a private company's stock is made available to the general public for purchase. Smaller businesses needing more money are more likely to issue initial public offerings (IPOs), although major private companies seeking to go public may still do so. IPOs can also be used to monetise the contributions of early private investors.
Companies release a public issue wherein they invite general public to contribute towards the equity and issue shares to meet their fund requirements by sharing ownership with investors. When one buys shares in the company, he/she becomes shareholders and for that matter owner in the company by the size of share value.
Why Do Companies Offer IPO?
An initial public offering (IPO) is a way for a company to raise money from the capital markets. The funds collected could be used for a variety of market needs, including capacity growth, product diversification, expansion into new geographies, major R&D, merger and acquisition operations, and so on.
The disclosure of proposed usage of the funds is to be mentioned in the issue prospectus.
The advantage for a company to raise funds via an IPO over other traditional financing channels like loans etc is the visibility in the public and the opportunity to improve market capitalisation.
In an IPO the issuing company takes the help of an Underwriting firm to determine the following:
What type of security to issue
The best offering price
The number of shares to be issued
The correct time to bring it to the market
The IPO Procedure
Some of the steps a private company takes to go public are as follows:
Choosing an Investment Bank
The first stage is to choose an underwriter from a list of investment banks. An investment bank's purpose is to support the firm in determining different information such as:
- How much capital the company hopes to raise
- The type of shares that will be sold
- The initial share price per share
For a large IPO, there can be multiple investment banks involved. In short, investment banks act as facilitators in the IPO process.
Red Herring Prospectus
The ‘Red Herring Prospectus' is the next step in the IPO process. This is accomplished with the assistance of underwriters. The prospectus includes various segments such as financial records, future plans for the company, potential risks in the market and expected share price range. Many times, underwriters go on road shows in order to attract potential institutional investors after they create the red herring prospectus.
Stock Exchange Approval
Listing is the process where securities are allowed to deal on a recognised stock exchange. But for that to happen, the company needs to be approved by the exchange.
Subscription of Shares
The firm makes the shares open to investors after all of the formalities have been completed. This is done on the dates specified in the prospectus. Investors who wish to apply for shares have to fill out and submit the IPO application form.
The shares are allotted to different investors based on the demand and price quoted in their IPO application forms. Once this is done, investors get the shares credited to their account.
Benefits of IPO
Getting In on the Action Early
This is particularly relevant when well-known firms announce an initial public offering. You have the opportunity to purchase the company's stock at a significantly reduced price. This is due to the fact that once the company's shares enter the secondary market, their value can skyrocket.
IPO investments are equity investments. So, they have the potential to bring in big returns in the long term. If the company’s fundamentals and future projections are strong, it has a good chance of growing bigger.
When a company gets listed on the stock market, it may be traded at a price that is either higher or lower than the allotment price. When the opening price is higher than the allotment price, it is known as listing gains.
Generally, investors expect an IPO to perform well on listing due to factors such as market demand and positive bias. However, this does not always happen. It is possible for a stock price to drop by the end of the first trading day too.
Media Coverage for Stock
As a firm is listed on a stock exchange, it attracts widespread public attention, increasing the exposure and appreciation of its products and services.