IPO
The act of introducing shares of a privately held firm to the general public through the issuance of new stock is known as an Initial Public offering (IPO), and it signifies the company’s entry into the stock market. By using this procedure, the business can attract financial backing from the general population.
Private investors may find the transition from being a private entity to becoming a public corporation to be a significant turning point because they may now fully realize the value of their investment and frequently receive a share premium. Additionally, it gives the general public the chance to participate in the share offering.
History of IPO
For a very long time, Wall Street and investors have been quite interested in the history of IPOs. The first modern IPO was carried out by the Dutch by selling shares of the Dutch East India Company to the general public. Companies have utilized IPOs over the years to generate money from the public by issuing ownership shares.
As technological and economic considerations have an impact on different sectors, IPO issuance has fluctuated throughout time. For instance, there was a spike in tech IPOs during the dotcom boom as businesses with no revenue rushed to go public.
The number of new offerings fell to its lowest level in a year as a result of the financial crisis in 2008, which had a severe impact on IPOs. After the recession, IPOs slowed down, and there weren’t many fresh listings for several years. Recently, the spotlight has been placed on “unicorns,” or startup businesses valued at over $1 billion. These businesses generate a lot of speculation from investors and the media as they evaluate whether to go public through an IPO or remain private.
A Few Things to Know About IPO Terms
Initial Public offerings (IPOs) have their unique lingo. Here are some essential IPO terms to help you understand it all:
| Term | Description |
|---|---|
| Common Stock | Ownership stakes in publicly traded companies. Dividends are paid to holders, who also have voting rights. sold throughout an IPO. |
| Issue Price | Price at which the company sells its common stock to investors before it trades publicly. also referred to as the asking cost. |
| Lot Size | Shares that must be purchased in order to participate in an IPO. Greater offers must be multiples of the lot’s dimensions. |
| Preliminary Prospectus (DRHP) | Contains information on management, financial statements, and business specifics. A “red herring” because of the red lettering. |
| Price Band | The company and underwriter will determine a price range for the IPO shares that investors can bid on. |
| Underwriter | Investment bank overseeing the IPO on behalf of the issuer. sets the Issue price, advertises the IPO, and distributes shares. |
| Fixed Price IPO | Companies decide on a fixed price before selling their shares for the first time. |
| Draft Red Herring Prospectus | A document announcing an IPO listing for a company after SEBI approval. |
| Under Subscription | Fewer stocks than the shares made available to the public received applications. |
| Oversubscription | Due to great demand, there are fewer shares available to the general public than there are applications. |
| Green Shoe Option | Underwriting agreements permit underwriters to sell additional shares when demand exceeds expectations. |
| Flipping | Reselling an IPO stock in the first few days to make a quick profit. |
How Does it Work
A corporation typically launches an IPO to raise money for future expansion, facilitate faster asset trading, increase equity capital, or provide current investors a chance to recoup their investments. Through the Prospectus, which includes full information about the planned offerings, both institutional investors and the general public can access the comprehensive information on the initial share sale.
As soon as the IPO is made public, the listed shares can be traded on the stock exchange. The minimum free float requirement for shares is established by the stock exchange in both absolute terms and as a percentage of the total share capital.
The company raises funds by offering new stocks, similar to IPOs, to investors in the Primary Market. Stocks can also be sold after the Initial Public offering (IPO) through private placement or preferential allocation to particular investors. On the other side, the equities that were allotted in the primary market are resold and traded among investors in the secondary market, also referred to as the stock exchange.
Types of Initial Public Offering (IPO)
IPOs generally come in two flavors. As follows:
Fixed Price Offering
The corporation sets a defined price for the initial sale of its shares in a fixed-price IPO. Prospective investors are made aware of this predetermined price. The market’s appetite for the company’s stocks becomes clear once the IPO closes. When submitting their applications, investors who take part in this kind of IPO must pay the full fixed price for the shares.
Book Building Offering
In a Book Building IPO, the company selling shares provides a price range, usually 20%, within which buyers can submit a bid on the shares before the ultimate price is established. The number of shares and price per share that interested investors are willing to purchase must be specified. The floor price and cap price are the two prices that make up the range; the floor price is the lowest. The bids made by the investors ultimately decide the share’s purchase price.
Understanding the IPO Process
Evaluating the Decision
The first step in the IPO process involves a thorough evaluation of the company’s readiness and strategic reasons for Going public. This entails evaluating a firm’s capacity to meet the requirements of a public corporation as well as its financial stability, market circumstances, and growth prospects.
Engaging Advisors
After deciding to move through with the IPO, the firm hires a group of experts to help them navigate the difficult process. These advisors include investment bankers, attorneys, auditors, and consultants.
Thorough Investigation and Record-Keeping
The organization performs thorough due diligence at this step to compile and confirm all pertinent financial and operational data. The information gathered is then utilized to create the registration statement, Prospectus, and other regulatory filings that are required for the IPO.
Underwriting and Pricing
The business chooses the investment bankers to work with when deciding the Offering price and the number of shares to be offered. To enable the IPO, underwriters are in charge of acquiring the shares from the company and selling them to the general public.
SEC Review
The Securities and Exchange Commission (SEC) thoroughly examines the submitted registration statement and other filings to make sure that all legal requirements are met.
Marketing and Roadshow
The company launches a marketing campaign and Roadshow before the IPO debut to attract potential investors to the offering. The company’s management and underwriters will make presentations at the Roadshow to highlight the company’s worth and future opportunities for expansion.
IPO Day and Listing
The company’s shares are made available to the general public on the selected stock market on the IPO day. The corporation becomes a publicly traded company after the stock is listed for trading.
Post-IPO Compliance
The business must continue to meet its ongoing compliance and reporting requirements after Going public, including those related to financial reporting, disclosures, and shareholder communications.
Staying Public
Being a publicly traded firm has ongoing duties and commitments. The business must handle the potential and risks of being a publicly listed organization while pursuing long-term growth and success while satisfying the interests of Shareholders.
Important Considerations When Investing in an IPO
- IPO Impact: When you own an IPO, you are directly tied to the company’s success or failure, affecting both.
- High Potential, High Risk: Due to the market’s erratic character, this asset could either richly reward you or cause your investment to lose all of its value without warning.
- No Obligation: Recognise that there is no assurance that funds will be returned to individual investors in public share offers.
- Assess and Consult: Consider the potential risks and rewards carefully before investing in an IPO. To get clarification, novices can consult wealth management companies or their financial consultants.
How to Invest in IPO
- To invest in an IPO, a firm must decide to raise money by Going public.
- The company carefully considers its potential advantages in terms of maximizing returns for early investors and raising capital for the business before deciding on an IPO as an exit option.
- Successful IPOs are probably going to have strong growth potential, which will draw hungry public investors.
- Underwriters often estimate the company’s future cash flows using a variety of valuation approaches, such as discounted cash flow, to calculate the IPO price.
- To ensure a successful IPO day, underwriters may lower the price and take into account demand.
- It can be difficult to analyze IPOs; investors should look to the Prospectus for key details, concentrating on the management team, the caliber of underwriters, and deal specifics.
- Successful IPOs frequently receive support from top Investment banks, which helps to promote them.
- The lengthy IPO process gives public investors time to follow news stories and information to determine the Offering price.
- Large private accredited individuals and institutional investors influence the IPO’s first trading day as part of the pre-marketing phase.
- On the final offering day, public investors participate, and for individual investors to participate, they often need trading access through brokerage platforms.
Examples of Stocks from Initial Public Offerings (IPOs)
Let’s look at a few actual examples to better comprehend the idea of an initial Public offering.
Example 1
On September 10, 2020, Unity Software (U) made its Stock market debut with an opening share price of $52. The stock closed at $78.39 a share on its first trading day, representing a significant 48% increase. The well-known video game production platform Unity Software allows for the creation and publication of both 2D and 3D games.
Example 2
DoorDash (DASH) debuted as a publicly listed business on December 9, 2020, with an opening share price of $102. The stock had a stunning 87% increase as it ended its maiden trading day at $189.50 per share. As a well-known food delivery service, DoorDash links customers with a variety of businesses.
Example 3
On April 14, 2021, Coinbase (COIN) listed on the stock market with an introductory share price of $380. The stock closed at $429.54 a share on its first trading day, a significant 14% increase. A well-known cryptocurrency exchange, Coinbase enables customers to purchase, sell, and trade a variety of cryptocurrencies.
Example 4
On March 10, 2021, Roblox (RBLX) made its debut on the stock market with an opening share price of $45. The stock marked a huge 42% increase as it ended its first trading day at $64.50 per share. A popular gaming platform that enables users to develop and play games is called Roblox.
IPO Performance and Factors Affecting Returns
- Investors constantly follow the performance of IPOs, which can be impacted by several variables.
- Investment banks may overhype some IPOs, which could result in initial losses. However, after coming public, many IPOs frequently experience trading gains.
- Lock-up periods, waiting periods, flipping practices, and tracking IPO stocks are important factors to take into account when evaluating IPO performance.
Lock-up Periods
- Stocks may see a big decline many months after an IPO, primarily as a result of the Lock-up period’s expiration.
- Lock-up agreements are legally binding arrangements that prohibit insiders (business officials and staff) from selling shares for a predetermined period.
- The Lock-up period can be anywhere between three and 24 months, however, underwriters may occasionally specify longer time frames.
- Insiders are permitted to sell their stock after the Lock-up period, which prompts a rush of buyers looking to take advantage of the opportunity to make a profit. The stock price may decline as a result of this surplus supply.
Waiting Periods
- Some shares are reserved for purchase after a certain amount of time by certain Investment banks who include waiting periods in the conditions of their offerings.
- If underwriters purchase this allotment, the price of the IPO could rise, and if they choose not to, it could fall.
Flipping
- Flipping is the practice of reselling Initial Public offering (IPO) stocks during the first few days to generate quick profits.
- When the stock is originally discounted and has big price increases on its first day of trading, this practice is typical.
Tracking IPO Stocks
- Tracking stocks can occasionally be produced by an existing firm by spinning off a portion of its operations into a separate company.
- The idea behind tracking stocks and spin-offs is that different business units inside a corporation may be worth more on their own than as a whole.
- For instance, it may be advantageous to separate a division from the parent business and raise extra funds through an IPO while keeping the parent company as a key shareholder if the division inside a slowly expanding corporation has strong growth potential but confronts significant current losses.
Investor Perspective
- Investment opportunities in fascinating IPOs are provided by spin-offs of established businesses.
- In many cases, vital information about the parent firm and its ownership of the sold entity is made available to investors.
- Potential investors benefit from having more information available, and this knowledge frequently causes spin-offs to have less initial volatility. Smart investors may come across advantageous chances in such circumstances.
Exploring Alternative Routes to Going Public and Beyond IPOs
| IPO Alternatives | Description | Pros | Cons |
|---|---|---|---|
| Direct Listing | Without underwriters, the issuer conducts the IPO and bases the Offering price on market demand | Higher share price potential | More risk for the issuer if the offering underperforms |
| Dutch Auction | IPO price not set; potential buyers bid for shares and the highest bidders get the allocated shares | Transparent and fair pricing process | Complexity in the bidding process |
| SPACs | Special Purpose Acquisition Companies raise money in an IPO to acquire other companies | Faster process for private companies Going public | Lack of transparency in the target company acquisition |
| Access to well-known Wall Street investors | Uncertainty about which companies will be acquired | ||
| Potential for high returns | Investors may not be informed of the target company | ||
| – | Some SPACs might not buy a business within 24 months |
Pros and Cons of IPO
Let’s explore the pros and cons of an IPO in this discussion.
 Pros |  Cons |
|---|---|
| Expanding and diversifying the company’s ownershipAccessing capital at a lower costEnhancing visibility, reputation, and public perceptionAttracting and retaining talented management and staffFacilitating acquisitions through stock issuanceGenerating various funding options (equity, debt, bank loans)Offering Tax Receivable Agreements for pre-IPO stakeholders | Substantial legal, accounting, and marketing expensesContinuous obligation to disclose financial and business dataDemanding significant commitment from managementRisk of failing to secure the required fundingPublic dissemination of information useful to competitorsLoss of control and increased agency conflicts with new investorsElevated risk of legal actions, including shareholder lawsuits |
In a Nutshell
- Companies can raise money from public markets through IPOs.
- The company’s exposure and brand familiarity increase after Going public.
- Existing Shareholders have the option to sell their shares, offering options for liquidity and diversification.
- IPOs build a company’s market value and increase its legitimacy.
- Companies can finance new projects, research, and expansion plans thanks to the money infusion.
- Increased regulatory compliance and reporting requirements follow becoming public.
- Initial stock prices might be impacted by market movements during IPOs.
- Transparent business practices are essential for publicly traded organizations since they face frequent media and public scrutiny.
- An IPO can provide an exit plan for early investors and venture capitalists, allowing them to realize profits on their investments.
- Long-term success is dependent on consistent growth and exceeding shareholder expectations.
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Frequently Asked Questions
1. Why Does a Company Decide to Offer an Initial Public Offering (IPO)?
Companies launch initial Public offerings (IPOs) to obtain money for a range of needs, including expansion, renovations, and debt repayment. Going public boosts liquidity and draws skilled people through stock ownership schemes. Additionally, it strengthens a company’s market position and increases its pride and reputation. A publicly traded corporation might also issue more shares to meet market demand and look into potential merger and acquisition targets.
2. What Factors Determine the Eligibility to Apply for an IPO?
A corporation must satisfy the following requirements to submit an IPO application:
- The minimum number of Shareholders who individually own at least 100 shares of the corporation is 400.
- There ought to be 1.10 million publicly traded stocks in total.
- The share price must be at least $4 in order to qualify for listing.
- At the time of listing, the company’s shares must have a minimum market value of $40 million.
- The three most recent years should have resulted in an overall profit before tax of $10 million, with pre-tax earnings in the preceding two years of at least $2 million and no losses in any of the three most recent years.
- At least $550 million must be invested in the market capitalization.
- The company should have generated at least $100 million in revenue the preceding year.
3. Does It Make Sense to Consider Investing in IPO?
Investments in initial Public offerings (IPOs) are risky, particularly given the lack of data about private companies that makes judgments more speculative. While some initial Public offerings (IPOs) have achieved large increases, many others have had negative returns after a few years. For instance, the Reliance Power IPO initially appeared promising but saw a considerable value loss within months following the market fall. Investors should exercise caution and refrain from believing that becoming public ensures a profitable long-term investment. It’s critical to avoid overpaying for an inflated IPO price because it can be difficult to recoup the money. Some experts advise delaying investing in IPOs until the price has stabilized after the Initial Public offering (IPO) craze has passed. With this strategy, the emphasis is shifted from conjecture to better-informed choice-making.
4. How Can Investors Safely Trade in IPOs?
The SEC urges prudence, particularly about IPOs. Investors should carefully read the company Prospectus, keep an eye on the Forms 10-K and 10-Q for signs of financial stability, assess the underwriter’s pricing strategy, and pay attention to factors like hype, trading volume, and selling Shareholders to engage in trading responsibly. The risks related to IPO trading can be managed by exercising diligence and knowledge.
5. What Categories Do Investors Fall Into?
Investors are categorized into three main groups:
Non-Institutional Investors: These investors include High Net Worth Individuals (HNIs), corporate entities, and other investors besides QIBs and RIIs. Depending on the type of issuance, different non-institutional investors receive different allocations.
Qualified Institutional Buyers (QIB): Significant investment firms, mutual funds, scheduled commercial banks, and other SEBI-registered organizations fall under this group. Depending on the nature of the issue, different amounts are set aside for QIBs.
Retail Individual Investors (RII): RII are individuals who submit applications for shares with a maximum application value of 2 lakh rupees. Depending on the nature of the problem, this category receives a different allocation.
