You might wonder what an initial public offering (IPO) is and how it operates since so many Indian firms have recently achieved unicorn status. Some have even decided to go public. This article covers the rationale for company IPOs and the advantages of doing so for investors.
What is Initial Public Offering?
An IPO is a procedure where a private firm releases its new stock shares for the very first time to the public. A firm may also raise equity funding from the general public via an IPO.
As there is often a share premium for current private investors, transitioning from a private firm to a public firm can be crucial for private investors to realise rewards from their investment completely. Furthermore, it enables public investors to take part in the sale.
What monetary conditions must a business meet before launching an IPO?
The following key criteria must be met for a firm to IPO and become publicly traded:
- Should have had net tangible assets totalling at least Rs. 3 crore in each of the three years prior, with up to 50% of those assets being held in financial assets.
- In three of the last five years, there should have been an average pre-tax operating profit of at least Rs 15 crore.
- Should have a net worth of a minimum of Rs. 1 crore over the three years prior.
- If the company's name was changed, at least 50% of the earnings from the prior year must be attributed to the name change.
- The issue cannot be worth more than five times the net worth before the issue.
Different Types of IPOs
- Fixed Price Offering: In this type of IPO, the issuing business sets the price at which its shares will be first offered for sale. The company will publicise the fee once it decides. We can determine the level of interest in a stock after the first subscription has ended.
- Book building: In book-building IPOs, the releasing business provides investors with a 20% price range on equities. Before the final price is set, interested parties can submit bids on the shares. The investors' bids would determine the price of the shares. Investors in a book-building IPO must state how many shares they want to purchase. Additionally, they must enter the price they are set to pay for a share. In this context, the term "floor price" refers to the lowest share price, whereas "cap price" denotes the highest price.
How does an IPO function?
An organisation is regarded as private before it does an IPO. These companies expand with fewer owners, such as early investors like the founders, friends, and family, as well as qualified investors, including angel investors or venture capitalists.
A firm taking part in an IPO is taking a significant step because it opens the possibility of significant raising of capital. This increases the firm's capacity for growth and development. Additionally, the enhanced trustworthiness and transparency of the share listing may help the firm get better terms when borrowing money.
A company will start publicising its interest as soon as it reaches a stage in the growth process where it considers mature enough to sell shares to public shareholders.
Based on the market competition and their capacity to meet listing standards, private companies with sound fundamentals and demonstrated profitability potential at varying values may also be eligible for an IPO.
Millions of investors can purchase firm shares and add money to the shareholders' equity of a company through the public market. Any person or institution interested in investing in the company is considered a member of the public.
Overall, the components that create the firm's new shareholders' equity value are the company's number of shares and the price at which its shares sell.
The IPO Process: What Is It?
There are two steps in the process of IPO. The pre-marketing stage is the first, and the actual IPO is the second. A firm that wishes to go public will request private bids through the underwriters or make a public announcement to attract interest.
The firm then selects the underwriters who oversee the IPO process. A business may choose one or more underwriters to manage certain phases of the IPO process jointly. The underwriters handle each step of the IPO process, including document preparation, due diligence, marketing, filing, and issuance.
IPO Steps:
- Proposals: The appropriate security type to issue, the number of shares, the offering price, as well as the anticipated time for the market offers are all stated in the proposals and their valuations that the underwriters submit.
- Underwriter: The corporation selects its underwriters through an underwriting agreement and formally accepts the terms of the underwriter.
- Documentation: The company's details are gathered for the necessary paperwork for an IPO.
- Promotion and Updates: For the new stock issuance's pre-marketing, marketing materials are prepared. Management and underwriters publicise the share issuance to identify a final offering price and gauge demand. Under the marketing process, underwriters can modify their financial analysis. This also entails altering the IPO price or the date of issuance if necessary. Firms take the required actions to satisfy particular demands for public share offerings.
- Board and procedures: Create a board of directors and ensure processes are in place to report quarterly auditable accounting and financial data.
- Issued Shares: On the date of the IPO, the company issues its shares. The balance sheet's stockholders' equity is shown on the cash statement received from the primary stage of issuing capital to shareholders. Each share's value on the balance sheet is then entirely dependent on the corporation's shareholders' equity per share valuation.
- After the IPO: Certain post-IPO provisions might be put in place. Following the day of the IPO, underwriters might have a set period to purchase more shares.
Advantages of IPO
One of the key benefits is that the firm can raise money by accepting investments from the whole of the investing public. This simplifies acquisition deals (share conversions) and improves the company's visibility, reputation, and public image, which can boost sales and profitability.
A firm can typically benefit from more favourable credit borrowing conditions than a private firm, thanks to the increased transparency coming along with compulsory quarterly reporting.
Disadvantages of IPO
Companies may encounter several drawbacks to going public and decide to adopt alternative tactics. Some significant disadvantages are the higher cost of IPOs and the ongoing and frequently unrelated sustaining costs of a public company.
For the management, which may be paid and assessed hugely on stock performance instead of actual financial outcomes, fluctuations in a company's share value can be a distraction. The business must publish financial, tax, accounting, and other business data. It may also be forced to divulge trade secrets and business strategies publicly during these disclosures, which could give rivals an advantage.
Keeping competent managers prepared to take chances may be more challenging if the board of directors has authoritarian leadership and governance. There is always the option to keep things secret. Companies may also request bids for a takeover rather than going public. In addition, businesses could look into several alternatives.
IPO investments
A company can only decide that an IPO is the best way to raise money and give early investors the most profit after a lot of research and analysis.
Therefore, the likelihood of future growth is strong, and many public investors will be in line to purchase shares for the first time when the IPO decision is made. An IPO might attract many buyers because IPOs are sometimes discounted.
Initially, the underwriters typically determine the IPO's pricing through their pre-marketing procedure. Fundamental methodologies are used to value the company as the basis for the IPO price. Discounted cash flow, the net present value of the firm's expected future cash flows, are some of the most widely utilised techniques.
On a per-share basis, underwriters and potential investors examine its worth. In addition, enterprise value, equity value, comparable firm adjustments, and more may be utilised to determine the price. The underwriters take demand into account, although they also frequently lower the cost to boost sales on the IPO day.
Analysing the technical and fundamentals of an IPO issuance can take time and effort. Investors will read the headlines, but the prospectus should be the primary source of information. There is a ton of helpful information in the prospectus. Investors should pay close attention to the management team's comments, the underwriters' qualifications, and the deal's specifications. Big investment banks that can effectively market a new issue often lead to successful IPOs.
In general, the path to an IPO is fairly drawn-out. As a result, as interest grows, public investors can keep up with breaking news and other facts to support their estimation of the ideal and prospective offering price.
Demand from major private accredited investors and institutional investors, who significantly impact the IPO's trading on its first day, is often included in the pre-marketing process. Public investors don't participate until the final offering day. All investors are eligible to participate, but only those with trading access can do so. Having an account with a brokerage platform like Upstox can help an individual investor to obtain shares.
Conclusion
A company's IPO shares get valued via underwriting due diligence. As soon as a firm goes public, the privately held shares get converted to publicly held shares, and the existing private shareholders' shares are now worth the public market price. The share underwriting may also include special terms for private to public share ownership.
FAQs
What is an Initial Public Offering used for?
Large corporations typically utilise IPOs to obtain money by selling their shares to the general public for the very first time. Shares of the company are traded on a stock exchange after an IPO. One of the major reasons for doing an IPO is to raise money through the sale of shares, to give firm founders and early investors liquidity, and to benefit from a greater value.
Can anyone invest in an IPO?
For a new IPO, there will frequently be greater demand than supply. Because of this, there is no assurance that all potential investors in an IPO will be able to buy shares. However, if an investor A mutual fund or other investment vehicle focusing on IPOs offers an additional investment choice.
Are IPOs a Smart Investment?
Much media attention is usually given to initial public offerings, some of which are done on purpose by the firm going public. In general, IPOs are well-liked by investors due to their propensity to induce erratic price changes on the IPO day and shortly after. Significant losses, as well as large gains, might occasionally result from this. Investors should ultimately evaluate each IPO in light of their financial situation, risk tolerance, and the prospectus of the company going public.
How are IPOs valued?
A corporation must list an initial value for its new shares when it goes public. The underwriters working on it are in charge of doing this. The fundamentals and growth prospects of the company play a significant role in determining the value of the company. Since IPOs could come from relatively young businesses, they might not yet have a demonstrated history of profitability. However, demand and supply for the IPO shares will also be important in the days preceding the IPO.