What is IPO and How Does it Work?

Companies release IPOs to raise money from the public and that is why IPOs are generally discounted. This makes IPO an attractive deal for companies since they can gain numerous buyers from primary issuance. Investors usually refer to the prospectus for referring to information related to the IPO. Since IPO is an important aspect of financial markets, studying online financial market courses can help investors in understanding the nitty-gritties of Initial Public Offering. Further enrolling in online investment banking courses are also helpful in creating strategies required to earn best returns on investments in financial markets.

 

Both retail or institutional investors can invest in an IPO. It is the fundamental step in the process of going public from a private business. This blog will help in building an understanding of what is IPO and how it works. 

Table of Contents

• What is IPO?
• Benefits of IPO for a Company
• How does it work?
• Why Should Investors Buy IPO?
• Process of Issuing an IPO
• Factors affecting the performance

What is IPO?

IPO or the initial public offering is the process of offering shares to public investors.Companies offer IPO with the aim to go public and raise funds to run their operations. Releasing an Initial Public Offering requires a team of experts who work till the end of the stock becoming public. In India, a mainline IPO is released in  the National Stock Exchange of India (NSE) and the Bombay Stock Exchange (BSE). Mainline IPO is the process through which the large- cap companies release their shares for the first time. SME IPO is listed on BSE SME platform and  NSE EMERGE.

Benefits of IPO

• Companies are privately owned before the release of IPO. Once they release shares publically, they can raise capital from public investors. 
• It increases the company’s public presence and helps them with easier acquisition deals. 
• There is a positive spike in the company’s sales and profits after the release of the IPO. 
• Companies use IPO to raise new equity capital so that they can monetize the investments of private shareholders. 
• It eases the process of trading existing holdings. After the release of the IPO, shares can be freely traded in the open market.

How an IPO Works?

The process of IPO works majorly in two stages. The first stage is the pre-marketing phase of the offering while the second stage is the initial public offering. When a company decides to release its IPO, it can do one of the two things. 

It can either issue a public statement announcing the release of IPO or it can solicit private bids by advertising it to underwriters. An underwriter is a professional that evaluates a party’s risk in lieu of a fee. The fee may include commission, interest or premium. A company may hire one or more underwriters. 

The underwriter leads the process. The professional is ensures due diligence, preparation of documents, filing, marketing of the IPO and its issuance. An IPO team consists of lawyers, certified public accountants (CPAs), underwriters and Securities and Exchange Commission (SEC) experts. Taking up online CPA courses can help a professional become CPA who can work as an underwriter for the company.

Process of Issuing an IPO

Let us now understand the entire process in detail.

1. The underwriters will underwrite terms through an agreement.
2. Underwriters will present the proposal and valuation to discuss various aspects of the IPO. These will include the number of shares, their services, offering prices, estimated timeframe for market 
3. The team compiles company-related information as a part of the IPO documentation. The S-1 registration statement is the primary IPO filing document. It includes the prospectus and private filing information. It also contains information related to the expected date of filing. The team revises the S-1 document throughout the pre-IPO process. 
4. Underwriters and executives work on the marketing materials for the pre-marketing of new stock issuance. These professionals market share issuance for estimating the demand. According to that, they decide a final offering price. 
5. The entire process might undergo constant revisions throughout the marketing process. Revisions may occur to IPO prices, issuance date and financial analysis.
6. After the formation of a board of directors, the company will issue shares on the IPO date. 

The company receives capital in the form of cash from the primary issuance to shareholders. This is recorded as the stockholder’s equity on the balance sheet. The share value becomes reliant on the company’s stockholder’s equity per share valuation.

Why Investors Should Buy IPOs?

1. Buying at the IPO price means you are investing in the company at its earliest stage as a public company. As the company keeps on growing, investors who have bought company's IPO can see significant returns.
2. Some IPOs will have a price jump on their first day of trading. This is known as "IPO pop" which can help investors gain immediate profits since they bought the IPO at the offering price.
3. Many companies will go public when they are in their growing phase which means there is a high chance that the investors are going to earn significant profits.
4. By investing in an IPO of a new sector company, investors get the chance to check if that new sector or industry is a fit for them.
5. IPOs often get significant media coverage, which creates market enthusiasm leading to an increase in the share prices in the short term.

Investment in Initial Public Offering

Companies release IPOs to raise money from the public and that is why IPOs are generally discounted. This makes IPO an attractive deal for companies since they can gain numerous buyers from primary issuance. Investors usually refer to the prospectus for referring to information related to the IPO. 

This prospectus is available as soon as the company files the S-1 registration. Before investing in an IPO, investors should learn about the specifics of the deal. They should also consider the management and underwriters for the specific Initial Public Offering. 

Factors Affecting The Performance of An IPO

There are a number of factors that are involved in the success or failure of an IPO. Let us see the factors that affect its performance:

1. Lockup Period

The lockup period is an important factor for assessing the performance of an IPO. Underwriters ensure that the company insiders sign a lock-up agreement. This prohibits insiders from selling shares of stock till a specific time period which may range between 3-24 months. 

After this lock-up period expires, there is no foundation on selling the stock. This leads to a surge in the selling of stock to realize profits. The excess supply of stock degrades the stock price. 

2. Flipping 

It is a practice of reselling the IPO within the first few days. Investors do so in order to realize quick profits. This usually happens when the stock is discounted.  

3. Tracking Stocks 

These are issued by the parent company and are presented as a special equity offering. These are useful in tracking the financial performance of the company stock. Investors can learn a lot about the parent companies through these spin-off stocks. 

IPOs are great for companies that want to gain short term gains and to attract investors. Since these are available at discounted prices, these may be great investment options. Before investing in IPOs, it is important to go through the prospectus and learn about the parent company of the IPO.