Initial Public Offerings (IPO) - Meaning, Working, and Benefits

IPO stands for Initial Public Offering. The process of going public through an IPO can take several months and involve extensive regulatory requirements and due diligence. Companies choose to go public through IPO for various reasons, including raising capital to fund growth. 

Successful IPOs can create significant wealth for founders and early investors, but not all IPOs are successful. Some companies have experienced a significant decline in their stock prices post-IPO. Let’s develop a better understanding of IPO by learning about its process, benefits, and risks. 

Points to be Discussed:

• What is an IPO?
• How does an IPO Work?
• Pros and Cons of IPO

What is an IPO?

In an Initial Public Offering (IPO), a private company offers shares to the general public in order to raise funds. The company’s shares are offered for sale on a public stock exchange, making it possible for both individual and institutional investors to acquire and sell them.

Companies decide to go public through an IPO for a variety of reasons, such as raising funds to support expansion, enabling early investors to sell their holdings, and gaining public visibility and credibility.

A company’s Initial Public Offering (IPO) can give investors the chance to make investments during its early years, but there are risks involved as well.

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How does an IPO Work?

The IPO process typically involves several steps, including filing a registration statement with the stock exchanges, going through a review and approval process, working with underwriters to set the offer price, and finally selling the shares to investors.

Let’s look at the various processes involved in an IPO. 

• Selecting underwriters- A company that wants to go public usually hires an investment bank or a group of investment bankers to act as the IPO’s underwriters. The underwriters give support during the offering process, assist in determining the offer price for the shares, and market the IPO to potential investors.
• Filing a registration statement- The company files a registration statement with the stock exchanges, which includes detailed information about the company’s financials, business operations, and risks associated with the investment.
• Going through the review process- The stock exchange reviews the registration statement and provides comments on areas that need further clarification or modification.
• Conducting a roadshow- The company and its underwriters conduct a roadshow to market the IPO to potential investors. During the roadshow, the company’s executives and underwriters meet with institutional investors, analysts, and other interested parties to discuss the company’s business and financial prospects.
• Setting the offer price- Based on feedback from the roadshow, the underwriters work with the company to determine the offer price for the shares.
• Allocating shares to investors- Once the offer price has been set, the underwriters allocate shares to investors who have expressed interest in purchasing the company’s stock.
• Going public- On the day of the IPO, the shares get listed on a public stock exchange and are made available to the public for trading. 
• Post-IPO- The company becomes a publicly listed company after the IPO, and anybody can buy and sell its shares from the open market. To keep shareholders up-to-date on business activities and results, the company must submit its business reports frequently to the stock exchanges.

Pros and Cons of IPO

An IPO can be a significant milestone for a company and offer multiple benefits, but it also comes with some risks that should be carefully considered before coming to a conclusion for this option. 

As an investor, when considering investing in a company that has gone public through an Initial Public Offering (IPO) or Follow-on Public Offering (FPO), there are several pros and cons to keep in mind. 

Here are some of the main advantages and disadvantages of IPO:

Pros of IPO

• An IPO can be an effective way for a company to raise a significant amount of capital by selling shares to the public.
•  IPOs offer investors the opportunity to invest in early-stage companies that have high growth potential before they become well-established.
• Going public can increase a company’s visibility and credibility, as well as its profile among potential customers, suppliers, and partners.
• Publicly traded stocks are generally more liquid than private investments, meaning that it is easier to buy and sell shares.
• A publicly traded company can use its stock as currency for potential acquisitions, which can be an attractive option for companies looking to grow.

Cons of IPO

• Preparing for an IPO can be a costly and time-consuming process, involving legal, accounting, and other expenses.
• Going public can result in a loss of control for founders and existing shareholders, as they may no longer hold a majority of the company’s shares.
• Investing in IPOs can be risky, as there is often limited information available about the company and its prospects.
• Many companies impose lock-up periods on insiders and early investors, during which they are not allowed to sell their shares, which can limit liquidity and put downward pressure on the stock price.
• Newly public companies can experience significant volatility in their stock price, which can be unsettling for some investors.

Conclusion

An Initial Public Offering (IPO) can be a profitable and exciting way for a business to raise capital by selling shares to the public. It’s important to keep in mind that an IPO is a complex, expensive process that needs careful planning, preparation, and execution, often guided by expertise learned in an investment banking course. Before considering an IPO, it’s critical for businesses to have a strong business model, solid financials, and a clear growth strategy.

The price of the stock may fluctuate greatly, and the market may experience sharp movements in the short term. So before investing in an IPO, as an investor, you should conduct your research, and think about your own risk tolerance, and long-term financial goals.