Finance

What is Initial Public Offering

Initial Public Offering

What is IPO?

An Initial Public Offering is a process of offering shares of a private company to the general public. It is a method of raising capital from investors. This gives a company chance to grow and expand. It is done through underwriting due diligence. The existing private shares convert to public shares and the shares become worth the public price. It is also referred to as “going public.” This is the first time that the owners of the company have given part of their ownership to the shareholders. Until then, the firm is owned privately.

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Types of IPOs:

There are generally 2 types:

  1. Fixed price offering
  2. Book building offering

Fixed Price Offering:

Under this method when going public the company decides a fixed price at which the shares are to be sold to the investors. Therefore the investors know the price before the company goes public. Demand is known only after the closure of the issue. The investors must pay the full share price while making the application.

Book Building offering:

Under this method, there is no fixed share price, unlike a fixed price offering. A 20% price band is given by which the investors are allowed to bid and the final price is determined after the closure. Demand for this is available on the BSE in real-time. The lowest share price is called the floor price whereas the highest share price is called the cap price.

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The IPO Process:

In order to go public, a private corporation must take various measures. They’re as stated below:

  1. Step 1-Selecting an Investment Bank:  The very first step in the IPO process for the issuing company is to choose an investment bank to provide the firm with guidance and underwriting services on its IPO. Multiple investment banks may engage in large IPO. They charge a fee between 3% and 7% of the IPO’s total sales price. 
  2. Step 2-Due Diligence: Due diligence and regulatory filings is the second step in the IPO process.  It consists of the leading investment banker, attorneys, accountants, corporate relations consultants, public relations practitioners, and SEC experts.
  3. Step 3-The IPO Roadshow:  This is the third step. Roadshow refers to promotional presentations organized in various locations to make up the initial public offering. To present their IPO, the underwriter and the issuing company travel to different locations.
  4. Step 4- IPO Price:  The underwriter and the firm can determine the effective date, the number of shares, and the initial offer price once authorized by the SEC. Usually, the price is determined by the company’s worth, which is worked out by the valuation process that takes place before the IPO process even starts. Pricing can also be influenced by the results of the roadshows and the state of the industry and economy.
  5. Step 5-Stabilization: This happens immediately after the IPO takes place. After it’s released, the underwriter establishes a market for the shares;  ensuring that enough buyers are available to hold the stock price at a reasonable level.
  6. Step6-Transition: The final stage of the IPO process, the transition to competition in the market. This usually starts 25 days after the initial public offering, with the end of the “quiet period” mandated by the SEC. The underwriters provide forecasts of the company’s revenues. This benefits investors when they move to rely on the company’s public information.

Pros of the IPO:

  • Fundraising
  • Exit opportunity
  • Increased Exposure and credibility
  • The reduced overall cost of capital
  • Stock as a means of payment

Cons of the IPO:

  1. Market pressures
  2. The potential loss of control
  3. Process incurs large  transaction costs
  4. The company is under continuous surveillance by the SEC.

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Conclusion

Initial Public Offerings are typically considered advantageous as they allow the issuer firm to grow its asset base and raise its engagement and reputation. However, an IPO may or may not be the right way for a company to raise capital. It comes with advantages as well as disadvantages. While considering an IPO one might calculate the risk involved and search for alternatives also.

 

Author – Priyanshu Ahuja

About the author – I’m a first-year student from City Premier College, Nagpur, pursuing BBA. My interest includes financial markets and investment domain.

 

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