Initial Public Offering(IPO)

 

What Is an Initial Public Offering (IPO)?

An initial public offering (IPO) refers to the process of offering shares of a private corporation to the public in a new stock issuance for the first time. An IPO allows a company to raise equity capital from public investors.

The transition from a private to a public company can be an important time for private investors to fully realize gains from their investment as it typically includes a share premium for current private investors. Meanwhile, it also allows public investors to participate in the offering. 

      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.

Key Points

An IPO or an Initial Public offering, is an offer of new shares of a private company to the public for the first time. Ownership changes hands - from being entirely privately held, the company is now giving ownership to the masses.

Not every company can afford to raise enough money from private investors. Also, going public presents other benefits than just raising capital.

As an investor, you stand to make extremely high returns on your investment if you pick the right IPOs.

How an Initial Public Offering (IPO) Works

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 IPO is a big step for a company as it provides the company with access to raising a lot of money. This gives the company a greater ability to grow and expand. The increased transparency and share listing credibility can also be a factor in helping it obtain better terms when seeking borrowed funds as well.

When a company reaches a stage in its growth process where it believes it is mature enough for the rigors of SEC regulations along with the benefits and responsibilities to public shareholders, it will begin to advertise its interest in going public.

Typically, this stage of growth will occur when a company has reached a private valuation of approximately $1 billion, also known as unicorn status. However, private companies at various valuations with strong fundamentals and proven profitability potential can also qualify for an IPO, depending on the market competition and their ability to meet listing requirements.

What Is the IPO Process?

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.

Steps to an IPO

1. Proposals. Underwriters present proposals and valuations discussing their services, the best type of security to issue, offering price, amount of shares, and estimated time frame for the market offering.
2. Underwriter. The company chooses its underwriters and formally agrees to underwrite terms through an underwriting agreement.
3. Team. IPO teams are formed comprising underwriters, lawyers, certified public accountants (CPAs), and Securities and Exchange Commission (SEC) experts.
4. Documentation. Information regarding the company is compiled for required IPO documentation. The S-1 Registration Statement is the primary IPO filing document. It has two parts—the prospectus and the privately held filing information.
5.  The S-1 includes preliminary information about the expected date of the filing.
6.  It will be revised often throughout the pre-IPO process. The included prospectus is also revised continuously.
7. Marketing & Updates. Marketing materials are created for pre-marketing of the new stock issuance. Underwriters and executives market the share issuance to estimate demand and establish a final offering price. Underwriters can make revisions to their financial analysis throughout the marketing process. This can include changing the IPO price or issuance date as they see fit. Companies take the necessary steps to meet specific public share offering requirements. Companies must adhere to both exchange listing requirements and SEC requirements for public companies.
8. Board & Processes. Form a board of directors and ensure processes for reporting auditable financial and accounting information every quarter.
9. Shares Issued. The company issues its shares on an IPO date. Capital from the primary issuance to shareholders is received as cash and recorded as stockholders' equity on the balance sheet. Subsequently, the balance sheet share value becomes dependent on the company’s stockholders' equity per share valuation comprehensively.
10. Post IPO. Some post-IPO provisions may be instituted. Underwriters may have a specified time frame to buy an additional amount of shares after the initial public offering (IPO) date. Meanwhile, certain investors may be subject to quiet periods.

Advantages and Disadvantages of an IPO

The primary objective of an IPO is to raise capital for a business. It can also come with other advantages as well as disadvantages.

Advantages:

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. 

Disadvantages:

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.

What are IPOs?

An Initial Public Offering or IPO is the first offering of shares to the public. Prior to an IPO, the company has a small number of shareholders (founding members and angel investors). You, as a retail investor, cannot buy shares of a company until the company offers to sell its shares to the public. To buy the shares of a company not listed on the stock market; you can approach the owners of the company but they are not obliged to sell you their stocks. Launching an IPO is often called ‘going public’, as public companies offer a portion of their shares to be traded in the stock market, to the public.

But launching an IPO isn’t very straight-forward:

Types of IPOs

Generally there are two types of IPOs. A company gets a boost when people start buying their equities. The two basic types of IPOs are

Fixed Price Issue

In a Fixed Price Issue, the price of the offerings are evaluated by the company along with their underwriters. They evaluate the company's assets, liabilities, and every financial aspect. They then work on these figures and fix a price for their offerings. The price is fixed after considering all the qualitative and quantitative factors. In a fixed price issue, the fixed price may be undervalued during the company’s IPO. The price is mostly lower than the market value. As a result, investors are always very interested in fixed price issue and ultimately revalue the company positively.

Book Building Issue

A book building issue is a comparatively new concept in India compared to other parts of the world. In a book building issue, there is no fixed price, but a price band or range. The lowest and the highest price is called ‘floor price’ and ‘cap price’ respectively. You can bid for the shares with the desired price you would like to pay. Thereafter the price of the stock is fixed after evaluating the bids. The demand of the share is known after each day as the book is built.

An IPO can be done through Fixed Price Issue or Book Building Issue or a combination of both.

Differences between Fixed Price issue and Book Building issue:

Price: The price of the share is fixed on the first day of the listing in fixed price issue and is printed in an order document whereas, in book building issue only the price band is fixed initially, the exact price is not fixed. Only after the closing date of bid, the exact share price is fixed.

Demand: The demand in a fixed price issue is known only after the closing of the issue whereas, in a book building issue, the demand for the share is known after each day.

Payment: In a fixed price issue, you need to pay 100% of the price of the share at the time of bidding for the share, but in case of book building issue, the payment can be completed after the allocation.

History of IPOs:

The term initial public offering (IPO) has been a buzzword on Wall Street and among investors for decades. The Dutch are credited with conducting the first modern IPO by offering shares of the Dutch East India Company to the general public.

Since then, IPOs have been used as a way for companies to raise capital from public investors through the issuance of public share ownership.

Through the years, IPOs have been known for uptrends and downtrends in issuance. Individual sectors also experience uptrends and downtrends in issuance due to innovation and various other economic factors. Tech IPOs multiplied at the height of the dotcom boom as startups without revenues rushed to list themselves on the stock market.

The 2008 financial crisis resulted in a year with the least number of IPOs. After the recession following the 2008 financial crisis, IPOs ground to a halt, and for some years after, new listings were rare. More recently, much of the IPO buzz has moved to a focus on so-called unicorns—startup companies that have reached private valuations of more than $1 billion. Investors and the media heavily speculate on these companies and their decision to go public via an IPO or stay private.

How to buy an IPO online?

An IPO is an allotment of shares to the public by a private company for the first time. Buying shares from an IPO has become very simple with online bidding and net-banking. Investing in IPOs can be very profitable if you make sound choices based on analysis of the company’s prospects. This article is a guide on how to bid for shares of an IPO online.

Key Points:

• To bid online, you need a demat account and a PAN card.
• Enter in the 16 digit depository participant ID provided to you by Upstox (the brokerage) and bid for the amount of shares you want to buy.
• Fill in the details as required and submit your application.
• After the shares are allotted, they are automatically deposited in your Upstox demat account.

How to apply for IPO Online?

To bid online, you need

• Demat account
• PAN card

You can open an online demat account or understand the online demat account opening process if need be.

To bid, make sure the IPO is open to you, the retail investor. This is what you have to do to buy shares online:

• Visit the website of the bank or the Depository Participant that provides for making application for the IPO.
• You must be a client of the bank or the Depository Participant to bid for shares.
• Enter in the 16 digit depository participant ID provided to you by Upstox (the brokerage) and bid for the amount of shares you want to buy. Fill in the details as required and submit your application.
• The bank sets aside the money for the bid through ASBA (Application Supported by Blocked Amount) system. You can't access the blocked amount which is transferred to the company after it allots you shares or is refunded back after the IPO closes if shares aren't allotted to you.
• After the shares are allotted, they are automatically deposited in your Upstox demat account.

Why should you bid online?

There are plenty of reasons you’d want to skip the offline paperwork intensive process:

Bidding online for an IPO is a hassle free and simple process that takes a few minutes at most.

Shares are allocated and credited automatically to your demat account.

All of your share holdings can be viewed at one place by logging into your Upstox account.

IPO allotment basics:

An IPO is an offer of shares of a private company to the public for the first time. Bids are received as long as the IPO is open and allotment of shares is determined after the IPO comes to a close. Read on to know how allotment is determined following an IPO.

Key Points:

In the book building process, bids are placed within a price range and finally a price is fixed. All of the bids at the fixed price and above get shares.

Normally, the shares in an IPO are divided into three categories - one reserved for institutional investors, one for non institutional investors and one for retail investors. Also, shares are sold in lots and not individually.

Usually, companies try to ensure that every bidder gets at least 1 lot of stock. Then, the remaining lots can be divided among bidders in proportion to the amount of lots they've bid for.

IPO allotment process

The IPO allotment process is fairly simple. Investors place bids for shares. If shares are offered at a particular fixed price (issue price), then all bids are made at that price. However, share price can also be fixed or discovered after assessing demand for the stock by the book building process.

In the book building process, bids are placed within a price range and finally a price is fixed. All of the bids at the fixed price and above get shares. Thus, if you think that there are chances that a particular IPO might be in a high demand, i.e. the IPO might be over-subscribed, it's always prudent to bid for shares at the cut off price. If you choose the cut off price option while bidding for shares, you will get shares at the cut off price determined later on.

But, what happens when more number of bids are received than there are shares? The company then divides up the shares among bidders.

What happens in case of oversubscription?

Companies distribute the shares among bidders if the number of bids exceed the total number of shares on offer (in other words, if oversubscription occurs). The shares are distributed proportionately among bidders based on the value of their individual bids.

Normally, the shares in an IPO are divided into three categories:

• one reserved for institutional investors,
• one for non institutional investors and
• one for retail investors.

It is important to remember that in case of an IPO, shares are sold in lots and not individually. Thus, if shares are sold in lots of 16, an investor has to bid for shares in multiples of 16 depending upon one lot or the multiple lots.

Significant oversubscription almost always occurs in the category of shares set aside for retail investors. Usually, companies try to ensure that every bidder gets at least 1 lot of stock. Then, the remaining lots can be divided among bidders proportionate to the number of lots they've bid for. If this is not possible, that is, if the number of bids is greater than the number of share lots, allotment is done by way of a computerised draw of lots.