What is an IPO (Initial Public Offering)?
An Initial Public Offering (IPO) is the procedure through which a privately-held business offers its shares to the public for the first time to raise funds. In addition, it allows the company to go public, and now it can be bought and sold in the stock markets. Normally, companies will execute an IPO in order to raise capital for specific purposes such as for growth, paying back obligations, or even financing research and development activities. IPOs give a chance to the investors to buy the shares of the company at the offering price, which is generally well below the expected price when the company is performing in the market.
What is the Purpose of an IPO?
The chief aim of an IPO is to augment capital. A public company has access to a vast market of investors and this makes it easy for the company to get funds to grow. Furthermore, becoming a public company has the potential of enhancing the image as well as the reputation of the company within the markets thus making it easy to mobilize resources in the future. On the other hand, an IPO is also a chance for the firm’s proprietors and early investors to cash out their equity stake and offer their shares to the market.
Types of IPOs
IPOs mainly come in two variant types:
- Fixed Price IPO
Once the fixed price IPO has been announced, an investor knows the price of the issuers shares prior to the purchase and it remains constant even after the shares have been offered for sale. After the sale is gone complete, shares are then available for trading at the
exchanges not before.
- Book Building Offering
Under this method of sharing ownership, the company gives out a price range within which the shareholders can bid. Each shareholder can call on a specified number of shares and at a price or prices not exceeding a specified maximum. Final price is then arrived at, on the basis of the demand and supplypatterns prevailing during the bidding. This enables the company to know about the level of interest of the investors towards its shares and the issue price is set at a level most appropriate to the prevailing market trends.
How Does an IPO Work?
The firm works together with investment banks referred to as underwriters to carry out the entire process of an initial public offering. The underwriters also help the company to set the share price, sell the offering to the investors, and make sure that all the rules are complied with. In addition, the company creates a prospectus which outlines in detail the financial standing of the company, the risks involved, and how the IPO proceeds will be utilized.
As a result of preparation on the company’s part, the threshold of the IPO is crossed by the general public where they can purchase shares. For some time, after the IPO has been completed, the firm’s shares are made available in a stock exchange which enables the trading of such shares in the primary market.
Advantages of Investing in an IPO
1. Potential of High Returns
In case a company excels after the IPO, it is most likely that the original share price will rise drastically allowing early investors to cash out considerably. For quite a number of enterprises, the hypothesis is that their share price grows as their profile increases giving investors cash-out opportunities.
2. Expansion of an Investment Game
By putting funds into an IPO, an investor can have a branch for companies in other industries without affecting much the other investments. This can be good in mitigating risk vis-a-vis rewards, especially for those investors willing to go into growth sectors.
3. Improved Reputation and Openness
After a firm crosses over to the stock market, many investors, analysts, and the media keep a close eye on it. This after scrutiny of the company may bring some positive changes in terms of business operations and responsibility which in turn would be good for the image and future of the company.
Disadvantages of Investing in an IPO
1. Unpredictability and Exposure
Risk in IPOs can be attributed to the fact that an investor can earn a lot or lose a lot. Share prices are subjected to the law of demand and supply which is known to be erratic. Often times, the stock value of the firms drops after its Initial Public Offering which is quite an unwise risk to assume if one does not have inside information.
2. Absence of Past Performance Information
The historical performance of initial public offering companies or rather new entrants in stock markets is short. It makes it easy for the investors to try and understand the company but the research or rather the analysis is only superficial and hence risky in regard to the investments made.
3. Responsiveness of Investments
Allure of investment quality fresh issues deteriorates with the rising stock market flotation costs since the bank managers’ and acquisition of shares costs involved are high. This translates to investors meaning that IPO investing can be overpriced for the equity offered.
Risks of Misusing an IPO
Investing in an IPO (initial public offering) involves certain understanding and strategic implementation, which is not the case for the majority of investors who do not perform due diligence prior to making a buy. The following highlights some of those risks:
- Overvaluation: an exaggerated IPO hype can in some cases lead to overpriced shares, which results in investors buying stocks above their fair value and in the long run suffering losses.
- Lack of liquidity: In circumstances where an investor purchases the stocks at an initial public offering followed by a poor stock performance, the stock’s investors might not be able to sell at a better price and make profits. Or, the market for the particular stock might be so Week that it does not have the necessary trading volumes and thus leaving investors with illiquid investments.
Terms Associated with IPO
1. Issuer
The issuing firm refers to the firm that sells its stocks to the public for the first time via an IPO.
2. Underwriter
Underwriters are mostly corporations that are either investment banks or financial institutions that assist the corporation in managing the IPO and its associated activities such as pricing, selling and marketing of the shares.
3. Prospectus
The prospectus refers to the all-inclusive document that consists of substantial information about the company, the company’s financials, the risks associated with investments, and the strategy for utilizing the raised funds.
4. Oversubscription
An oversubscription is a situation whereby the demand for shares is greater than the supply made for those shares. This can cause the price to rise as investors internally compete for the small number of shares available.
5. Green Shoe Option
A green shoe option permits the underwriters to sell extra stocks in the event that there is unanticipated demand for the offered shares.
IPO Eligibility Criteria
Becoming a part of any IPO tends to be regulated where a number of conditions have to be met such as having a valid ID having a PAN card and having a Demat account. On the other hand, in investors wish to dispose of the IPO shares after their listing, trading account is a must for them.
Conclusion
For some investors the option of investing in an IPO is a possibility as they can purchase shares of a company during its infancy stage. Nonetheless, it is best to also understand the dangers that are presented in this such as the risk of turbulent markets, inactivity and even the costs cut out by the IPOs. Investors however can do proper homework and why research is important so that profits can be made out of the emergence of new organizations.
FAQs on IPO:
1. How is IPO performed in the business?
Regarding IPO, the organization collaborates with the underwriters to arrive at a specific share price, marketing the shares by publishing a prospectus and issuing the shares to the public with trading of shares in a stock exchange. The shares are then made available for trading at a stock exchange.
2. Is an IPO profitable?
IPOs can also be regarded as profit-making activities especially when the stock price of the firm increases after the firm goes public. Nevertheless, they include risks as well and can be hard to predict the market.
3. Should you consider investing your money in an IPO?
In particular, IPOs are often considered the best bet for such investors able to bear the risk and do the homework. However, investors unwilling to take such risk may find it undesirable.
4. How can an investor sell IPO stock?
An investor can sell his/her shares when the IPO is already printed in the stock exchange by issuing a sell order on the shares through a trading account.
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