What is an Initial Public Offering (IPO)?

An IPO is a big step for any company as it gives the company access to raising a good amount of money. This gives the company an opportunity to grow and expand. It also increases credibility which further helps the company in obtaining debt as the credibility and transparency have been increased.

• What is an Initial Public Offering (IPO)?
• How does it benefit the company?
• Should you invest in an IPO?

What is an Initial Public Offering (IPO)?

An initial public offering (IPO) is the process through which shares of a private corporation are offered to the public in a new stock issuance. The process to issue IPO takes place in the primary market. It is also known as the new issue market. Public share issuance helps a company by allowing it to raise capital from public investors. The transition which takes place from a private to a public company can be a crucial time for the private investors to realize most of the gains from their investment as mostly it includes share premiums for the current private investors. It means giving shares in the exchange of funds or money.

How does it benefit the company?

A company is considered a private company before the IPO. As we know that a private company has fewer shareholders. Mostly a private company has promoters and professional investors as the shareholders. When a company feels that it need to expand and it is in a position to go through the lengthy process of IPO. It also believes that the company is in a position where it can comply with all the regulations needed for IPO. When a company goes public the ownership is converted to the public from private. The worth of the private shareholders also changes to the public trading price.

There is no exact mark in terms of valuation or turnover. When a company feels the need for more funds and is capable of handling the responsibilities towards public shareholders. A company may opt after reaching a certain valuation or a company may believe that they have strong fundamentals and that’s why they are ready to issue IPO.

The reasons why the company goes public are

• To repay the borrowed money: The company goes public to raise money so that they can repay their debt. They also want to decrease their interest payments as the payment of the dividend is not mandatory but the payment of debt is mandatory.

• Increase visibility: Company would like to be known by more people and by going public they can not only increase their visibility but also get new deals because of their increased visibility.

• Expand and grow: Most companies go public because they need funds to grow and expand. With the increase in funding, they can invest in new technology or expanding their reach to other countries, promoting their product in other parts of the country, they may like to invest in research and development, etc.

• Provide an exit option to angel investors: Various investors invest money at the time of formation of the company. These investors would like to take the return of the investment. The easiest option for the investors to exit is by making the company go public. The money raised through IPO is used to pay them.

• To give a good return to the investors who are exiting: The investors who want to exit of course want maximum return which is only possible by the way of IPO. Most of the time when the company goes public the value of the company increases.

• Publicity: The Company expands its consumer base by going public as now more people know it because of advertisements in newspapers for the issue of IPO.

• To increase credibility: When a company goes public transparency also increases as the company has to follow the rules set by the regulator. This increases the trust among other stakeholders of the company.

• To increase their debt capacity: When the company has more equity, then the company can take more loans. It reduces the equity to debt ratio with the introduction of more equity capital.

Should you invest in an IPO?

This question revolves in every investor’s mind who is willing to invest in the IPO. The answer to this question depends on certain parameters. These parameters will help you in analysing the IPO of the company. Let’s talk about the advantages of investing in an IPO:

• First mover advantage

IPO means that it is a new issue and if you take part then you will be among the first few people to own the security. Therefore, this gives you the first-mover advantage. When the shares will go to the secondary market price of the share may skyrocket.

• Price transparency

When you get the security through IPO you know the exact price you are paying. But once the security gets listed in the secondary market the price will depend on the changing market scenario.

• High returns

If the growth potential is high that means you can earn huge gains in long run. You will buy the security at lower rates and sell it at higher rates. When the company expands or grows.

There are various advantages of investing in an IPO. But these advantages differ from one company to another company. Taking part in IPO is more of a gamble than an investment. One may lose money if the investor has paid more money for the security than its actual worth. A company is going public doesn’t mean that it has good growth prospects nor it means that it is a good long term investment. You may have heard people telling you that they gained a huge amount through IPOs. The reality is more people lose money in IPO than the people who gain money. But no one likes to talk about their losses, we all want to talk about the gains we made. One of the most common reasons which people lose money is because of the inflated IPO price.

If you are thinking of buying an IPO then keep in mind not to overpay. Rather wait for some time let the IPO get over, let everything settles down and then buy the security.