Initial public offering is the process by which a private company can go public by sale of its stocks to general public. It could be a new, young company or an old company which decides to be listed on an exchange and hence goes public.
Companies can raise equity capital with the help of an IPO by issuing new shares to the public or the existing shareholders can sell their shares to the public without raising any fresh capital.
A company offering its shares to the public is not obliged to repay the capital to public investors.
The company which offers its shares, known as an ‘issuer’, does so with the help of investment banks. After IPO, the company’s shares are traded in an open market. Those shares can be further sold by investors through secondary market trading.
An IPO (initial public offering) is referred to a flotation, which an issuer or a company proposes to the public in the form of ordinary stock or shares. It is defined as the first sale of stock by a private company to the public. They are generally offered by new and medium-sized firms that are looking for funds to grow and expand their business.
It is also referred to as “public offering”
Basics of private and public:
A privately held company has fewer shareholders and its owners don’t have to disclose much information about the company. Most small businesses are privately held, with no exceptions that large companies can be private too, like Domino’s Pizza and Hallmark Cards being privately held. Shares of private companies can be reached through the owners only and that also at their discretion. On the other hand, public companies have sold at least a portion of their business to the public and thereby trade on a stock exchange. This is why doing an IPO is referred to going public.
The main reason for going public is to raise the good amount of cash through the various financial avenues that are offered. Besides, the other factors include:
- Public companies usually get better rates when they issue debt due to increased scrutiny.
- As long as there is market demand, a public company can always issue more stock.
- Trading in the open markets means liquidity.
- Being Public makes it possible to implement things like employee stock ownership plans, which help to attract top talent of the industry.
Factors to be considered before applying for an IPO:
There are certain factors which need to be taken into consideration before applying for Initial Public Offerings in India:
- The historical record of the firm providing the Initial Public Offerings
- Promoters, their reliability, and past records
- Products offered by the firm and their potential going forward
- Whether the firm has entered into a collaboration with the technological firm
- Project value and various techniques of sponsoring the plan
- Productivity estimates of the project
- Risk aspects engaged in the execution of the plan
General Terms involved in IPO:
Primary market: It is the market in which investors have the first opportunity to buy a newly issued security as in an IPO.
Prospectus: A formal legal document describing the details of the company is created for a proposed IPO, also making the investors aware of the risks of an investment. It is also known as the offer document.
Book building: It is the process by which an attempt is made to determine the price at which the securities are to be offered based on the demand from investors.
Over-Subscription: A situation in which the demand for shares offered in an IPO exceeds the number of shares issued.
Green shoe option: It is referred to as an over-allotment option. It is a provision contained in an underwriting agreement whereby the underwriter gets the right to sell investors more shares than originally planned by the issuer in case the demand for a security issue proves higher than expected.
Price band: Price band refers to the band within which the investors can bid. The spread between the floor and the cap of the price band is not more than 20% i.e. the cap should not be more than 120% of the floor price. This is decided by the company and its merchant bankers. There is no cap or regulatory approval needed for determining the price of an IPO.
Listing: Shares offered in IPOs are required to be listed on stock exchanges for the purpose of trading. Listing means that the shares have been listed on the stock exchange and are available for trading in the secondary market.
Flipping: Flipping is reselling a hot IPO stock in the first few days to earn a quick profit. The reason behind this is that companies want long-term investors who hold their stock, not traders.