A Complete Guide to Understand Initial Public Offerings (IPOs)

The Indian stock market is experiencing a huge influx of initial public offerings (IPOs) as companies capitalize on investor optimism and a strong economy. In Q3 of 2023 alone, there have been more than 34 mainboard IPOs, not including smaller SME listings, according to the EY Global IPO Trends Report. This surge is driven by a mix of tech giants, established companies, and promising startups.

Initial Public Offering (IPO): What It Is and How It Works

If you’re considering getting into the stock market or investing in companies, it’s important to understand what IPO means. To start with IPO full form is Initial Public Offering, and it’s when a company goes from being privately owned to becoming a public company that anyone can invest in. It’s like the company’s debut on the stock exchange, where people can buy and sell its shares.

How does an Initial Public Offering (IPO) Work?

Going public through an IPO helps companies raise money from investors, allowing them to grow and expand. So, if a business decides to go public, it can gather enough money from people who want to invest in it.  This helps the company get money for growth. At the same time, people who buy these shares can make money if the company does well. So, it’s like a win-win situation: companies get funds to grow, and investors can earn by owning a piece of the company.

What Is an Initial Public Offering (IPO)?

An Initial Public Offering, or IPO, is the first time a private company’s shares are sold to the public on a stock exchange. Generally, companies start small, often owned by family or friends. But as they grow, they need more money to expand and succeed. That’s when they think about going public or having an IPO. To understand IPO’s meaning clearly, let’s learn more about Initial Public Offerings.

 Key Takeaways

• IPOs allow private companies to raise funds for growth and expansion.
• Shares become publicly traded, allowing investors to become part owners.

• Companies must meet standards set by the Security and Exchange Board of India.
• Companies work with investment banks to market the IPO, check demand, and set the price and date.
• An IPO can be a way for a company’s founders and early investors to profit by selling their shares to the public.

 History of IPOs

 In 1602, the Dutch East India Company wanted to get rich with spices and allowed everyone to buy shares (like certificates) from them. This move led to the creation of the world’s first IPO. More companies, like American banks and big tech names like Amazon, joined this financial journey as time passed. Nowadays, IPOs are still an exciting way for companies to get money and share their story.

 What Is the IPO Process?

The IPO process has two main parts. First, there’s the pre-marketing phase, where a company shows interest in going public. It can privately ask for bids or publicly announce its plans to create interest.

The company picks underwriters to lead the IPO. These underwriters, chosen by the company, manage various aspects of the process, from checking details to preparing documents, filing, marketing, and issuing the IPO. The underwriters play a key role in making the whole IPO process happen.

Steps to an IPO

• Selecting an Underwriter:
  • Hire an investment bank as an underwriter to guide you through the IPO process.
  • Underwriters are like a bridge between the company and investors, evaluating finances and working on deal details.
• IPO Registration:
  • Develop a registration statement and a Red Herring Prospectus.
  • Submit the Red Herring Prospectus with essential disclosures to meet SEBI and Companies Act requirements.
• SEBI Verification:
  • SEBI reviews submitted documents and grants approval if satisfied.
• Share Pricing:
  • Determine share prices based on market dynamics.
• Marketing and Advertising:
  • Advertise the IPO to attract potential investors.
  • Use presentations, online roadshows, and meetings to create positive company awareness.
• Share Allotment:
  • Allocate shares to IPO applicants.
• Listing of Shares:
  • Once allotment is complete, list shares on the stock exchange.

 Advantages and Disadvantages of an IPO

The main goal of an IPO is to gather funds for a business. Along with potential benefits, there are also advantages and disadvantages to consider.

 Advantages

• Get Money for Growth: With an IPO, a business can raise funds for growing, paying debts, and research.
• Easy Selling for Shareholders: IPO lets existing shareholders, like founders or early supporters, sell some or all of their shares.
• Boost Company Visibility: Being on a stock exchange makes a company more visible, attracting more customers.
• Long-term Credibility: Being listed gives a business long-term credibility in the market.

Disadvantages

• Costly Process: Going public is expensive, with higher costs for underwriting, legal, accounting, and other compliance matters.
• Disclosure Demands: Businesses need to share financial, accounting, tax, and other business details, which rivals might use to their advantage.
• Ownership Dilution: Being listed on a stock exchange means original investors have to decrease their ownership as new investors come in.

 IPO Alternatives

 Direct Listing

A direct listing is like an IPO, but no middlemen called underwriters are involved. Instead of using underwriters to help sell its shares, the company goes straight to the stock market. This means the company takes on more risk if things don’t go well, but the share price might be higher if all goes smoothly. However, this direct listing usually works best for a company with a well-known brand and a good business.

 Dutch Auction

In a Dutch auction, people who want to buy stocks bid for how much they’ll pay. The ones willing to pay the most get the stocks at the price they offer. It’s like an auction where the highest bidders win.

 Investing in an IPO

When a company chooses to raise funds through an IPO, it gives early investors good returns and raises a lot of money. So, when they decide to go for the IPO, they expect the company to grow. Many people are interested in buying shares for the first time. Usually, IPO shares are sold at a lower price to ensure many people buy them, making them even more appealing, especially when they want to buy them immediately.

 Performance of IPOs

Many things can influence how much money you make from an IPO. Investors pay close attention to this. Sometimes, investment banks make a big deal about an IPO, but it doesn’t always mean you’ll make money at first. Still, most IPOs usually make money in the short term when they’re first available to the public. There are a few important things to think about when it comes to how well an IPO does.

 Lock-Up

Lock-up agreements are binding contracts between underwriters and company insiders, like officials and employees. They prevent insiders from selling stock for a set period, often ranging from three to twelve months. When lock-ups end, insiders can sell their stock, creating a rush to profit. This surge in supply can significantly lower the stock price as everyone tries to sell at once.

 Waiting Periods

Some investment banks include waiting periods in their offering terms, setting aside shares for purchase after a specific time. If the underwriters buy these reserved shares, the price may rise; however, it could decrease if they choose not to.

 Flipping

Flipping involves quickly reselling IPO stocks in the initial days to make a fast profit. This often occurs when the stock is sold at a discount and experiences a  surge on its first day of trading.

 Tracking IPO Stocks

Tracking IPOs involves following upcoming IPOs to stay informed about new investment opportunities. This includes monitoring listing dates, company details, and potential performance to make informed investment decisions. Sometimes, instead of making the whole company public, a company lets a part of itself grow on its own through a “spin-off.” 

For investors, these special IPOs can be good. The original company’s involvement gives important information about the new part, making it easier to decide. So, when a familiar part becomes independent, smart investors might see a chance to succeed.

 What Is the Purpose of an Initial Public Offering?

An IPO is a way for big companies to raise funds by selling their shares to the public for the first time. After an IPO, the company’s shares are bought and sold on a stock exchange. Reasons for doing an IPO include raising money through share sales and giving founders and early investors a way to turn their investments into cash.

 Can Anybody Invest in an IPO?

When a new company goes public, many people want to buy its shares, but there might not be enough for everyone. So, it’s unclear if all interested investors can get them. People wishing to join can check with their brokerage firm, but sometimes, only big clients get access. Another way is investing through a mutual fund or something similar that deals with new companies going public.

Is an IPO a Good Investment?

When a company goes public,  it often gets a lot of attention from the media. Companies may even try to get more attention on purpose. People like IPOs because the prices of the company’s shares can change a lot on the first day and shortly after. This can lead to big profits, but it can also mean big losses. To decide if it’s a good idea to invest, people should look at the IPO details, like the company’s finances and how much risk they can handle. 

How Is an IPO Priced?

When a company goes public (IPO), it sets a starting price for its new shares. Banks, called underwriters, handle this and try to market the deal. The company’s value is mainly based on its basics and growth potential.  However, the IPO shares’ demand and supply also affect the price before the IPO happens. Sometimes, newer companies in IPOs don’t have a proven record of making money, so they compare with similar ones.

QUICK LINKS:

CURRENT IPOS | LISTED IPOS | UPCOMING IPOS