Advantages and Disadvantages of Initial Public Offerings (IPO)

Initial Public Offering, or IPO, refers to turning a privately held business into a public one. Smart investors can make a handsome return on their investments (ROI) through an IPO. 

 

An investment in an IPO has the potential to deliver attractive returns. However, before investing, it is important to understand how the process of trading these securities differs from ordinary stock trading, along with the additional risks and rules associated with IPO investments.

 

Also Read | All You Need to Know About the Microfinance Sector

 

What is an IPO?

 

An Initial Public Offering (IPO) is when a privately held company makes its shares available for public purchase. IPOs allow companies to raise capital by issuing and selling new shares of stock to the public. In exchange for the investment, shareholders receive ownership in the form of stock and become part owners of the company.

 

The process of going public involves several steps. First, the company must prepare a prospectus, which outlines the company's financial information and business plans. The company must also file various forms with the Securities and Exchange Commission (SEC) to comply with securities regulations. Once the SEC has approved the prospectus, the company can begin marketing the IPO to potential investors.

 

The company typically works with an investment bank, which underwrites the offering and helps the company price the shares. The investment bank may also provide support with regulatory compliance and offer advice on marketing and distribution of the shares.

 

Once the shares are sold, the company becomes publicly traded and its stock can be bought and sold on an exchange. The IPO process can bring many benefits to the company, including increased visibility, better access to capital, and the ability to use stock options as a form of compensation for employees.

 

However, going public can also have its drawbacks, including increased regulatory requirements, loss of privacy and control, and higher costs associated with being a public company. Additionally, there is also the risk that the stock price may decline after the IPO, causing a loss of value for investors.

 

IPOs are an important tool for companies looking to raise capital and take their business to the next level. While there are many factors to consider before going public, an IPO can be a valuable opportunity for companies that are ready to leap.

 

Also Read | IPO and NFO: How are They Different?

 

What are the different Types of IPO?

 

There are several types of Initial Public Offerings (IPOs), including

 

1. Fixed Price IPO: 

 

In this type of IPO, the company sets a fixed price for the shares being offered and the investors place their orders at the set price. The shares are then allocated based on the demand.

 

2. Book Building IPO: 

 

This type of IPO involves the company setting a price range for the shares and investors placing bids within that range. The final price of the shares is determined based on the demand and supply. This type of IPO is commonly used to gauge investor interest and set the most favorable price.

 

3. Dutch Auction IPO: 

 

This type of IPO involves the company setting a price range for the shares and inviting investors to place bids. The shares are then allocated to the highest bidders at the lowest price necessary to sell all of the shares being offered.

 

4. Reverse Book Building IPO: 

 

In this type of IPO, the company sets a price range and invites investors to place bids at a price lower than the range. The final price is determined by the highest price at which all the shares can be sold.

 

5. Best Efforts IPO: 

 

This type of IPO is typically used by smaller companies and involves the investment bank agreeing to do its best to sell the shares but not guaranteeing a specific number of shares will be sold or a specific price will be achieved.

 

6. Direct Listing: 

 

Direct Listing is a process by which a company can bypass the traditional IPO process and list its shares directly on a stock exchange without issuing new shares or raising capital. This type of IPO is becoming more common among technology companies.

 

Each type of IPO has its advantages and disadvantages, and the choice of which type to use depends on the company's specific needs and goals. Companies should carefully consider their options and work with a financial advisor to determine the best course of action.

 

Also Read | All You Need To Know About Initial Coin Offering or ICOs

 

Steps in IPO: 

 

The steps involved in an IPO (Initial Public Offering) typically include the following:

 

1. Hire an underwriter: 

 

The company seeking to go public usually hires an investment bank or a group of investment banks to act as underwriters for the IPO. The underwriter helps the company to determine the price of the shares, and the size of the offering, and to prepare the registration statement for the Securities and Exchange Commission (SEC).

 

2. Due diligence: 

 

The company and the underwriter conduct extensive due diligence to ensure that all information in the registration statement is accurate and complete. This includes financial information, company history, legal and regulatory issues, and other material information that would be important for investors to know.

 

3. SEC filing: 

 

The company files a registration statement with the SEC, which includes a prospectus that provides details about the company and the proposed offering. The SEC reviews the registration statement and provides feedback and comments to the company.

 

4. Waiting period: 

 

After the registration statement is filed, there is a waiting period of approximately 20 days during which the SEC reviews the registration statement and provides feedback to the company. Once the SEC approves the registration statement, the company can proceed with the IPO.

 

5. Price determination: 

 

The company and the underwriter work together to determine the price of the shares. This involves considering market conditions, the company's financial performance, and investor demand.

 

6. Roadshow: 

 

The company and the underwriter conduct a series of presentations to potential investors, known as a roadshow. The roadshow is designed to generate interest in the IPO and to provide investors with information about the company and the proposed offering.

 

7. Allocation of shares: 

 

Once the price has been determined, the underwriter allocates shares to investors. This includes determining the number of shares to be sold to institutional investors and retail investors.

 

8. Listing: 

 

The company's shares are listed on a stock exchange, such as the New York Stock Exchange (NYSE) or NASDAQ, and begin trading on the public market. The IPO process can be lengthy and complex process, but it can provide companies with access to additional capital and increased visibility.

 

Also Read | What are Shares? Definition and Types
 

---

Process of Initial Public Offering (IPO)

---

 

Pros of an IPO:

 

An Initial Public Offering (IPO) can provide several benefits to a company, including

 

1. Raising Capital: An IPO allows a company to raise capital by issuing and selling new shares of stock to the public. This capital can then fund growth, develop new products and services, and improve existing ones.

 

2. Improved Valuation: An IPO provides a company with an objective valuation of its business, as the market determines the value of the company based on demand for its stock. This can be particularly valuable for startups and early-stage companies that are seeking a valuation benchmark.

 

3. Liquidity: An IPO provides liquidity for early investors, founders, and employees by allowing them to sell their shares in the company. This can be particularly valuable for startups and early-stage companies.

 

4. Increased Visibility: An IPO increases the visibility of a company, making it more well-known to investors, customers, and the general public. This increased visibility can help to attract new customers, partners, and employees.

 

5. Improved Access to Capital: Public companies generally have an easier time accessing capital through stock offerings or debt financing, as there is a greater pool of investors willing to invest in publicly traded companies.

 

6. Employee Motivation: Companies can also use stock options as a form of compensation for employees, providing them with an incentive to help grow the business.

 

7. Improved Governance: Going public typically requires companies to adhere to more stringent regulatory and reporting requirements, which can lead to improved governance and better management practices.

 

8. Enhanced Credibility: Being a publicly traded company can enhance the credibility of a company and increase its perceived stability and reliability, making it more attractive to customers, partners, and employees.

 

While there are many potential benefits to going public, companies should also consider the drawbacks, such as increased regulatory requirements, loss of privacy and control, and higher costs associated with being a public company. Companies should work with a financial advisor to determine if an IPO is the right move for their business and to help navigate the process.

 

Also Read | Top 15 US IPOs of All Time

 

Cons of an IPO

 

An initial public offering (IPO) is the process by which a privately-held company becomes publicly traded. While an IPO can provide several benefits for a company, including increased visibility, access to capital, and the ability to motivate employees with stock options, it also has several drawbacks, including

 

1. Increased regulatory requirements: Once a company goes public, it is subject to several regulations, such as the Securities and Exchange Commission's (SEC) reporting requirements, which can be time-consuming and costly to comply with.

 

2. Short-term focus: Public companies are often under pressure to deliver short-term results to meet the expectations of shareholders. This can lead to a focus on quarterly earnings at the expense of long-term growth and innovation.

 

3. Dilution of ownership: When a company issues new shares in an IPO, existing shareholders' ownership is diluted, which can reduce the value of their holdings.

 

4. Increased scrutiny: Public companies are subject to increased public scrutiny, which can be difficult to handle, especially if the company experiences financial difficulties or negative publicity.

 

5. Loss of control: Going public can result in the loss of control for the company's founders and early investors, as decision-making power is transferred to the public shareholders.

 

6. Market fluctuations: The value of a public company's stock can be impacted by market fluctuations, which can make it difficult for the company to plan for the future.

 

7. Risk of lawsuits: Public companies are at an increased risk of lawsuits from shareholders or other parties, which can be costly and time-consuming to resolve.

 

Also Read | Everything You Need To Know About the Bull Market

 

Important Terms About IPO:

 

Here are some important terms about IPO (Initial Public Offering):

 

1. Underwriter: An underwriter is an investment bank or a group of investment banks that helps the company to price and sell its shares to the public.

 

2. Prospectus: A prospectus is a legal document that provides information about the company and the proposed offering to potential investors. It includes information on the company's business model, financial statements, risk factors, and other important information that investors need to make an informed decision about whether to invest.

 

3. Securities and Exchange Commission (SEC): The SEC is a government agency that regulates securities markets in the United States. Companies that want to go public must file a registration statement with the SEC and provide ongoing disclosures to the SEC and investors.

 

4. IPO Price: The IPO price is the price at which the company offers its shares to the public. This price is determined by the company and the underwriter and is based on market conditions and other factors.

 

5. Market capitalization: Market capitalization refers to the total value of a company's outstanding shares. It is calculated by multiplying the number of shares outstanding by the current market price.

 

6. Lock-up period: The lock-up period is a period after an IPO during which certain insiders, such as company founders and executives, are prohibited from selling their shares.

 

7. Book building: Book building is a process in which the underwriter and the company work together to determine the demand for the shares and to price the offering.

 

8. Green shoe option: A green shoe option is a provision that allows the underwriter to sell additional shares to investors if demand for the shares is high. This can help stabilize the price of the shares and ensure that the offering is successful.

 

These are some of the important terms related to the IPO process that investors and companies should be familiar with.

 

Also Read | Privatization: Meaning, Advantages, and Disadvantages

 

End Note:

 

In conclusion, an IPO (Initial Public Offering) is the process by which a private company becomes a publicly traded company by offering its shares to the public for the first time. 

 

The IPO process typically involves several steps, including hiring an underwriter, conducting due diligence, filing a registration statement with the SEC, determining the price of the shares, conducting a roadshow to market the offering, and listing the shares on a stock exchange.

 

Going public through an IPO can provide a company with increased access to capital, greater liquidity for its shares, and increased visibility and credibility. However, it also involves high costs and regulatory compliance requirements and may result in increased public scrutiny and pressure to meet earnings expectations.

 

Investors who are interested in investing in IPOs should carefully consider the company's prospectus, financial performance, and risk factors before investing. They should also be aware of the potential for high volatility in the stock price in the early days of trading.

 

Overall, an IPO can be a significant event in the life of a company and can provide both opportunities and challenges. Companies and investors who are considering an IPO should work with experienced professionals to navigate the process and achieve a successful outcome.