Understanding IPO: A Beginner’s Guide to Initial Public Offerings
Introduction
If you’ve ever heard in news or by friends about companies “going public” or seen headlines about Initial Public Offerings (IPOs) , you might be wondering what is IPO ? Well then you are right place to understand about IPO. In this post, we have explained everything you need to know about IPOs in simple terms, as a promise from financewisdom4u to educate everyone in financial literacy.
What is an IPO?
Initial Public Offering (IPO) is a process through which a private company becomes a public company by selling its shares to the general public for the first time
In simpler terms it is like inviting everyone to become a part owner of the company by buying a piece of it.
Why do companies go for an IPO?
To understand why do companies go for an IPO let understand . There can be many reason companies go for an IPO.
1. Need interests free funds in exchange of sharing part of business to public : Imagine you started a small business and it grew to the point where you needed more money to expand. Now, you have many options to acquire funds for expansion such as a bank, private equity, via bonds, etc. You don’t want to pay any interest on the borrowing from banks or bonds, and you don’t want to give control to private equity venture capitalists.
So you have decided that you can raise funds from the public by going through an IPO. This allows you to raise a significant amount of money by selling shares to a large number of investors and it is interest-free money. The only thing you have to do is give a partnership or a percentage of shares in the business in exchange for the funds raised.
2. Providing Exits to Existing Private Equity VCs:
Companies often receive investments from venture capitalists (VCs) during their initial days of business. Once the business grows VCs eventually want to cash out their investments. Going public through an IPO provides an exit strategy for these private equity investors. By selling their shares on the stock market , they can turn their initial investment into cash and allowing them to reap the rewards of their investment.3. Providing Employees the Opportunity to Liquidate Their Shares:
In many companies, employees are given stock options as part of their compensation. These stock options allow employees to buy shares of the company at a predetermined price. When a company goes public, employees can sell their shares on the open market and cash out. This not only provides financial benefits to employees but also fosters a sense of ownership and loyalty among the employees.4. Enhancing Reputation:
Going public can significantly boost a company’s reputation. Being listed on a stock exchange brings visibility and credibility. It signals to the market and the public that the company has reached a certain level of maturity and financial stability. This enhanced reputation can attract more customers, investors, and business partners, further fueling the company’s growth and success.
In summary, companies choose to go public for various reasons, including raising interest-free funds, providing exits for private equity investors, offering employees a chance to liquidate their shares, and enhancing their overall reputation in the business world. Each of these factors plays a crucial role in the decision-making process leading up to an IPO.
What are the steps in the IPO process?
- Company Preparation:
Before the IPO the company needs to get its financial house in order. It must disclose its financial health, business model and plans for the future. This information is compiled in a document called a prospectus. - Hiring Experts:
The company usually hires investment banks to help with the IPO process. These banks assist in setting the IPO price, finding potential investors and navigating the regulatory requirements. - SEC Approval:
The U.S. Securities and Exchange Commission (SEC) is like the referee in the IPO game. They review all the information the company provides to ensure it’s accurate and complete. Once approved the company can move forward with the IPO. - Setting the Price:
The company and its investment banks work together to determine the initial price at which shares will be sold to the public. This is a crucial step because it influences how much money the company will raise and how much investors will pay for a share. - Going Public:
On the big day the company officially becomes public by listing its shares on a stock exchange, such as the New York Stock Exchange (NYSE) or the Nasdaq. Investors can now buy and sell the company’s shares on the open market. In India it lists on the NSE and BSE exchanges.
What are the benefits of an IPO for a company?
- Access to Capital:
Companies can raise a substantial amount of money which can be used for various purposes like expanding operations, paying off debts or investing in new projects. - Increased Visibility:
Going public puts a company in the spotlight. It becomes more well-known attracting attention from investors, customers and the media. - Currency for Acquisitions:
Publicly traded companies can use their stock as a form of currency to acquire other companies. This is like saying, “We’ll give you shares of our company in exchange for yours.” - Employee Benefits:
Employees often receive stock options as part of their compensation. When a company goes public these options can become more valuable and provide employees with a share in the company’s success.
What are the risks of IPOs?
- Market Volatility:
The stock market can be unpredictable and the price of a newly public company’s shares may go up and down. It will going to impact investors returns. - Increased Scrutiny:
Public companies are under constant scrutiny from investors, analysts and the media. Any mis-step can lead to a drop in the stock price and damage the company’s reputation. - Regulatory Requirements:
Public companies must adhere to strict reporting and compliance standards set by regulatory bodies like the SEC (in USA) / SEBI (in India). This can be time-consuming and costly.
Some Examples of IPOs
- Facebook (2012) – US : Facebook, the social media giant, went public in 2012. Its IPO raised a whopping $16 billion, making it one of the largest IPOs in history.
- Alibaba Group (2014) – US : Alibaba, the Chinese e-commerce giant, made headlines with its $25 billion IPO on the New York Stock Exchange.
- Snap Inc. (2017) – US : Snapchat’s parent company, Snap Inc., went public in 2017. Despite facing challenges, it generated significant interest from investors.
- Indian Railway Finance Corporation Ltd. (2021) – India : Indian Railway Finance Corporation (IRFC) went public in 2021. As a dedicated financing arm of Indian Railways, the IPO aimed to raise funds for various railway infrastructure projects.
Conclusion
In summary, an IPO is like a company’s grand debut on the stock market allowing it to raise funds, increase visibility and provide investment opportunities for the public. While there are benefits companies must also navigate risks and meet regulatory requirements. Understanding the IPO process opens the door to a whole new world of finance and business and it helps to enhance one’s understanding of investing.