INFORMATION
2024-02-01T16:02:44
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Rishabh Jain
2024-02-01T16:02:44 | 2 Mins to read
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IPO stands for "initial public offering." This is when shares of a private company are first sold to the public. With an IPO, a business can get money from public buyers in the form of shares.
As a business goes from being private to public, it may be important for private investors to get a share premium. This is because private investors usually get more shares when the company goes public. At the same time, it lets regular people invest in the deal.
KEY TAKEAWAYS
An initial public offering (IPO) refers to the process of offering shares of a private corporation to the public in a new stock issuance.
Companies must meet requirements by exchanges and the Securities and Exchange Commission (SEC) to hold an IPO.
IPOs provide companies with an opportunity to obtain capital by offering shares through the primary market.
Companies hire investment banks to market, gauge demand, set the IPO price and date, and more.
An IPO can be seen as an exit strategy for the company’s founders and early investors, realizing the full profit from their private investment.
IPO is an acronym that stands for Initial Public Offering. An Initial Public Offering (IPO) is the procedure via which a privately held firm or corporation transitions to a public entity by selling a portion of its ownership to investors.
An initial public offering (IPO) is typically undertaken to inject fresh equity capital into the company, enable smooth trading of existing assets, generate funds for future endeavors, or convert the investments made by current stakeholders into cash.
The prospectus provides access to the details of the initial public offering (IPO) for institutional investors, high net worth individuals (HNIs), and the general public. The prospectus is an extensive document that provides a comprehensive description of the specific details of the prospective offerings.
After the completion of the initial public offering (IPO), the company's shares are officially listed and can be freely traded on the open market. The stock exchange mandates a minimum free float requirement for shares, which must be met both in absolute terms and as a proportion of the entire share capital.
Before an IPO, a company is considered private. As a pre-IPO private company, the business has grown with a relatively small number of shareholders including early investors like the founders, family, and friends along with professional investors such as venture capitalists or angel investors.
An Initial Public Offering (IPO) is a significant milestone for a company since it offers the organization the opportunity to secure substantial funds. This enhances the company's capacity to thrive and extend its operations. The enhanced openness and legitimacy of being listed on the stock market might also contribute businesses obtaining more favorable terms when seeking loans.
Once a firm deems itself sufficiently developed to comply with SEC requirements and assumes the associated advantages and obligations to public shareholders, it will commence promoting its intention to become a publicly traded entity.
Usually, this phase of expansion takes place when a firm has achieved a private valuation of around $1 billion, sometimes referred to as unicorn status. Nevertheless, private enterprises with solid foundations and demonstrated potential for profitability may also be eligible for an initial public offering (IPO), contingent upon market competition and their ability to satisfy listing criteria.
The pricing of IPO shares is determined through the process of underwriting due diligence. When a corporation becomes publicly traded, the ownership of formerly privately held shares is converted to public ownership, and the value of the shares held by private shareholders is determined by the public trading price. Share underwriting may encompass specific requirements for the ownership transition from private to public shares.
Meanwhile, the public market opens up a huge opportunity for millions of investors to buy shares in the company and contribute capital to a company’s shareholders' equity. The public consists of any individual or institutional investor who is interested in investing in the company.
Overall, the number of shares the company sells and the price for which shares sell are the generating factors for the company’s new shareholders' equity value. Shareholders' equity still represents shares owned by investors when it is both private and public, but with an IPO, the shareholders' equity increases significantly with cash from the primary issuance.
There are two common types of IPO. They are-
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.
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 the floor price, and the highest stock price is known as the cap price. The ultimate decision regarding the price of the shares is determined by investors’ bids.
The phrase initial public offering (IPO) has been a prominent term in the financial industry and among investors for many years. The Dutch are acknowledged with pioneering the first contemporary Initial Public Offering (IPO) by making shares of the Dutch East India Company available to the general public.
Subsequently, initial public offerings (IPOs) have served as a means for firms to generate funds from the general public by offering shares of ownership to the public.
Over time, Initial Public Offerings (IPOs) have been associated with both upward and downward trends in the number of issuances. Issuance in each industries fluctuates due to innovation and numerous economic conditions, resulting in both uptrends and downtrends. During the peak of the dotcom boom, there was a significant increase in the number of initial public offerings (IPOs) by technology companies. These IPOs were mostly pursued by startups that had not yet generated any income, but were eager to become publicly traded on the stock market.
The 2008 financial crisis led to a year with the fewest first public offerings (IPOs). Following the economic downturn that occurred after the 2008 financial crisis, initial public offerings (IPOs) came to a complete stop, and for several years thereafter, there were very few new companies going public. In recent times, there has been a shift in the IPO hype towards a certain group of startup businesses known as "unicorns". These are companies that have achieved private valuations above $1 billion. Investors and the media engage in extensive speculation over these companies and their deliberation on whether to conduct an initial public offering (IPO) or remain privately held.
The IPO process essentially consists of two parts. The first is the pre-marketing phase of the offering, while the second is the initial public offering itself. When a company is interested in an IPO, it will advertise to underwriters by soliciting private bids or it can also make a public statement to generate interest.
The underwriters lead the IPO process and are chosen by the company. A company may choose one or several underwriters to manage different parts of the IPO process collaboratively. The underwriters are involved in every aspect of the IPO due diligence, document preparation, filing, marketing, and issuance.
The primary objective of an IPO is to raise capital for a business. It can also come with other advantages as well as disadvantages.
One of the key advantages is that the company gets access to investment from the entire investing public to raise capital. This facilitates easier acquisition deals (share conversions) and increases the company’s exposure, prestige, and public image, which can help the company’s sales and profits.
Increased transparency that comes with required quarterly reporting can usually help a company receive more favorable credit borrowing terms than a private company.
Companies may confront several disadvantages to going public and potentially choose alternative strategies. Some of the major disadvantages include the fact that IPOs are expensive, and the costs of maintaining a public company are ongoing and usually unrelated to the other costs of doing business.
Fluctuations in a company's share price can be a distraction for management, which may be compensated and evaluated based on stock performance rather than real financial results. Additionally, the company becomes required to disclose financial, accounting, tax, and other business information. During these disclosures, it may have to publicly reveal secrets and business methods that could help competitors.
Rigid leadership and governance by the board of directors can make it more difficult to retain good managers willing to take risks. Remaining private is always an option. Instead of going public, companies may also solicit bids for a buyout. Additionally, there can be some alternatives that companies may explore.
| Pros | Cons |
| Can raise additional funds in the future through secondary offerings |
Significant legal, accounting, and marketing costs arise, many of which are ongoing |
| Attracts and retains better management and skilled employees through liquid stock equity participation (e.g., ESOPs) |
Increased time, effort, and attention required of management for reporting |
| IPOs can give a company a lower cost of capital for both equity and debt |
There is a loss of control and stronger agency problems |
A direct listing is when an IPO is conducted without any underwriters. Direct listings skip the underwriting process, which means the issuer has more risk if the offering does not do well, but issuers also may benefit from a higher share price. A direct offering is usually only feasible for a company with a well-known brand and an attractive business.
In a Dutch auction, an IPO price is not set. Potential buyers can bid for the shares they want and the price they are willing to pay. The bidders who were willing to pay the highest price are then allocated the shares available.
When a company decides to raise money via an IPO it is only after careful consideration and analysis that this particular exit strategy will maximize the returns of early investors and raise the most capital for the business. Therefore, when the IPO decision is reached, the prospects for future growth are likely to be high, and many public investors will line up to get their hands on some shares for the first time. IPOs are usually discounted to ensure sales, which makes them even more attractive, especially when they generate a lot of buyers from the primary issuance.
Initially, the price of the IPO is usually set by the underwriters through their pre-marketing process. At its core, the IPO price is based on the valuation of the company using fundamental techniques. The most common technique used is discounted cash flow, which is the net present value of the company’s expected future cash flows.
Underwriters and interested investors look at this value on a per-share basis. Other methods that may be used for setting the price include equity value, enterprise value, comparable firm adjustments, and more. The underwriters do factor in demand but they also typically discount the price to ensure success on the IPO day.
Overall, the road to an IPO is a very long one. As such, public investors building interest can follow developing headlines and other information along the way to help supplement their assessment of the best and potential offering price.
The pre-marketing process typically includes demand from large private accredited investors and institutional investors, which heavily influence the IPO’s trading on its opening day. Investors in the public don’t become involved until the final offering day. All investors can participate but individual investors specifically must have trading access in place. The most common way for an individual investor to get shares is to have an account with a brokerage platform that itself has received an allocation and wishes to share it with its clients.
Several factors may affect the return from an IPO which is often closely watched by investors. Some IPOs may be overly hyped by investment banks which can lead to initial losses. However, the majority of IPOs are known for gaining in short-term trading as they become introduced to the public. There are a few key considerations for IPO performance.
If you look at the charts following many IPOs, you'll notice that after a few months the stock takes a steep downturn. This is often because of the expiration of the lock-up period. When a company goes public, the underwriters make company insiders, such as officials and employees, sign a lock-up agreement.
Lock-up agreements are legally binding contracts between the underwriters and insiders of the company, prohibiting them from selling any shares of stock for a specified period. The period can range anywhere from three to 24 months. Ninety days is the minimum period stated under Rule 144 (SEC law) but the lock-up specified by the underwriters can last much longer.4 U.S. Securities and Exchange Commission. "Revisions to Rules 144 and 145: A Small Entity Compliance Guide." The problem is, when lockups expire, all the insiders are permitted to sell their stock. The result is a rush of people trying to sell their stock to realize their profit. This excess supply can put severe downward pressure on the stock price.
Some investment banks include waiting periods in their offering terms. This sets aside some shares for purchase after a specific period. The price may increase if this allocation is bought by the underwriters and decrease if not.
Flipping
Flipping is the practice of reselling an IPO stock in the first few days to earn a quick profit. It is common when the stock is discounted and soars on its first day of trading.
Closely related to a traditional IPO is when an existing company spins off a part of the business as its standalone entity, creating tracking stocks. The rationale behind spin-offs and the creation of tracking stocks is that in some cases individual divisions of a company can be worth more separately than as a whole. For example, if a division has high growth potential but large current losses within an otherwise slowly growing company, it may be worthwhile to carve it out and keep the parent company as a large shareholder then let it raise additional capital from an IPO.
From an investor’s perspective, these can be interesting IPO opportunities. In general, a spin-off of an existing company provides investors with a lot of information about the parent company and its stake in the divesting company. More information available for potential investors is usually better than less and so savvy investors may find good opportunities from this type of scenario. Spin-offs can usually experience less initial volatility because investors have more awareness.
Important: IPOs are known for having volatile opening day returns that can attract investors looking to benefit from the discounts involved. Over the long term, an IPO's price will settle into a steady value, which can be followed by traditional stock price metrics like moving averages. Investors who like the IPO opportunity but may not want to take the individual stock risk may look into managed funds focused on IPO universes. But also look out for so-called hot IPOs that could be more hype than anything else.
A: An initial public offering is when the private firm sells its first shares of stock to the general public. In essence, an IPO indicates that a company's ownership is changing from private to public. As a result, the IPO process is often known as "becoming public."
A: An IPO is essentially a fundraising method used by large companies, in which the company sells its shares to the public for the first time. Following an IPO, the company’s shares are traded on a stock exchange. Some of the main motivations for undertaking an IPO include: raising capital from the sale of the shares, providing liquidity to company founders and early investors, and taking advantage of a higher valuation.
A: Oftentimes, there will be more demand than supply for a new IPO. For this reason, there is no guarantee that all investors interested in an IPO will be able to purchase shares. Those interested in participating in an IPO may be able to do so through their brokerage firm, although access to an IPO can sometimes be limited to a firm’s larger clients. Another option is to invest through a mutual fund or another investment vehicle that focuses on IPOs.
A: IPOs tend to garner a lot of media attention, some of which is deliberately cultivated by the company going public. Generally speaking, IPOs are popular among investors because they tend to produce volatile price movements on the day of the IPO and shortly thereafter. This can occasionally produce large gains, although it can also produce large losses. Ultimately, investors should judge each IPO according to the prospectus of the company going public as well as their financial circumstances and risk tolerance.
A: When a company goes IPO, it needs to list an initial value for its new shares. This is done by the underwriting banks that will market the deal. In large part, the value of the company is established by the company's fundamentals and growth prospects. Because IPOs may be from relatively newer companies, they may not yet have a proven track record of profitability. Instead, comparables may be used. However, supply and demand for the IPO shares will also play a role on the days leading up to the IPO.
A: They are an excellent way to invest your money because they provide enormous profits at a much lower risk than other possibilities. If the company does well, you can acquire relatively tiny stocks and significantly boost your profits.
A: Investing in an IPO can be a good decision. If you get in on the ground base of a stock with tremendous upside potential, you could reap the benefits later on as the price appreciates over time.
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