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Initial Public Offering (IPO): Process and Working

  • Bhumika Dutta
  • Dec 12, 2021
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Many financial enthusiasts participate in investing in different fundings. One of such funds is Initial Public Offering (IPO). An initial public offering (IPO) is a way for a private company to become listed on a stock market and have its shares traded there. 

 

When a firm decides to raise money through an IPO, it does so only after extensive research and analysis to ensure that this exit plan maximizes early investor returns while also raising the greatest capital for the company.


 

Understanding IPO

 

The term "Initial Public Offering (IPO)" refers to a company's first public offering of stock to the general public. A follow-on public offer (FPO) is when a corporation offers its shares to the public but not for the first time. 

 

An IPO allows a firm to raise funds from the general public. The move from a private to a public firm, which often involves a share premium for current private investors, can be a crucial opportunity for private investors to completely realize the rewards from their investment. Meanwhile, public investors are allowed to participate in the offering.

 

To apply for an IPO, one must first get a subscription form from one of the issue's collecting centers, syndicate members, or bankers. After completing the form, it must be submitted to the issue's collection centers or collecting bankers. Shares are allocated through a bidding procedure and put in the investor's Demat account.

 

(Related reading: Top US IPOs)

 

 

Process of applying for an IPO

 

An initial public offering (IPO) is divided into two sections. The first is the offering's pre-marketing phase, and the second is the actual first public offering. 

 

When a firm wants to do an IPO, it will either request private bids from underwriters or make a public declaration to attract interest. 

 

To apply for an IPO, some steps must be followed by the interested customer, as reported by the Economic Times:

 

  1. The customer should first go to the ongoing IPO area of the broker's trading app or mobile application, choose an investor category and an initial public offering (IPO) to apply for, and enter the number of shares they want to buy and the price they want to sell them for. The UPI id must also be supplied.

  2. Once the application has been filed with all of the required information, a mandate request is to be sent by the customer to the UPI application for approval. The applicant must accept the mandate request by logging into the UPI application. The money for the IPO is blocked after it is accepted.

  3. If no shares are granted after allotment, the full blocked sum is unblocked. If portion allotment is required, the required amount is deducted from the bank account, and the remaining amount is unblocked. If the applicant receives all of the shares for which he or she applied, the whole sum is deducted.

  4. It must be noted that, if the individual applying is not the same as the person whose bank account was used to apply for the IPO, the application may be refused.

 

 

How does an IPO work?

 

Investopedia has published a thorough blog about IPOs, which has helped us understand how they function. 

 

A corporation is considered a private company before it becomes public, and its investors are limited to a few stockholders such as the founders, family and friends, venture capitalists, and angel investors. 

 

An initial public offering (IPO) is a significant milestone for a company since it allows it to raise significant funds. This increases the company's capacity to develop and grow. The enhanced openness and legitimacy of its stock listing may also help the company acquire better terms when seeking borrowed capital.

 

Underwriting due diligence is used to price a company's IPO shares. When a corporation goes public, private share ownership transforms to public ownership, and existing private shareholders' shares are valued at the public market price. 

 

Special arrangements for private to public share ownership can be included in share underwriting. Meanwhile, the public market provides millions of investors with the option to purchase shares in a firm and contribute funds to its shareholders' equity. 

 

Any individual or institutional investor that is interested in investing in the firm is considered a member of the public. The number of shares sold and the price at which they are sold are the elements that determine the equity value of the company's new owners.

 

An IPO's return is influenced by a number of variables. The bulk of initial public offerings (IPOs) are noted for gaining in short-term trading when they are released to the public. The following are some of the aspects that influence an IPO's performance:

 

  1. Lock-Up Agreements: Lock-up agreements are legally enforceable arrangements between underwriters and business insiders that prevent them from selling any stock for a set length of time. 

All insiders are allowed to sell their stock after their lockups expire. As a result, many are rushing to sell their shares in order to cash in on their profits. The stock price might be severely impacted by this surplus supply.

  1. Waiting Periods: Waiting periods are included in the terms of several investment banks' offerings. This sets aside some shares for purchase when a certain amount of time has passed. If the underwriters buy this allotment, the price may rise; if not, the price may fall.

  2. Flipping: The practice of reselling an IPO shares during the initial few days of its release in order to make a rapid profit is known as flipping. It happens frequently when a stock is heavily undervalued and then surges on its first day of trade.

  3. Long-term IPOs: IPOs are renowned for having erratic first-day returns, which might draw investors wanting to take advantage of the discounts. An IPO's price will settle into a consistent value over time, which may be tracked using typical stock price indicators like moving averages. Investors who want to participate in the IPO market but don't want to risk their money on individual stocks might choose managed funds that specialise in IPO universes.

 

(Catch also: Preference Shares V/s Equity Shares)

 

Advantages of IPO:

 

Till now we have learned about IPOs and their work, but now we are going to understand the benefits that an IPO can provide to any company:

 

  1. To raise funds, the firm receives investment from the whole investing public. This makes acquisition negotiations simpler, as well as increasing the company's visibility, prestige, and public image, all of which can assist sales and profitability.

  2. Increased openness, such as that provided by compulsory quarterly reporting, may typically assist a public corporation to obtain better credit borrowing conditions than a private one.

 

Disadvantages of IPO:

 

Like advantages, an IPO can cause many disadvantages to a company.

 

  1. IPOs are costly, and the costs of running a public company are ongoing and sometimes unrelated to other business expenses.

  2. Management may be rewarded and assessed primarily on stock performance rather than genuine financial results, thus fluctuations in a company's share price can be a distraction.

  3. Financial, accounting, tax, and other business information must be disclosed by the company. It may have to publicly share secrets and business processes that might aid competitors during these disclosures.

  4. The board of directors' rigid leadership and governance might make it more difficult to retain strong managers who are ready to take risks. It's always possible to remain anonymous.


 

Conclusion

 

As we have discussed till now, an IPO is a technique of obtaining funds for major corporations in which the firm offers its shares to the public for the first time. 

 

For a new IPO, there is frequently more demand than supply. As a result, there is no certainty that all interested investors will be able to acquire shares in an IPO. 

 

Those interested in participating in an IPO through their brokerage company may be able to do so, albeit access to an IPO may be limited to the business's bigger clients. Investors should evaluate each IPO in light of the company's prospectus, as well as their financial situation and risk tolerance.

 

(Also read: Initial Coin Offering)

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