What is IPO? – Meaning, types, process & eligibility

IPO, short for initial public offering, is a common term in stock market investing. A private firm becomes a public corporation by issuing shares. IPO offers a great opportunity for the general public to participate and profit from their investments.

When they start out, most firms depend on the initial capital invested by their founders, venture capitalists, and other funding sources. Typically, a firm decides to launch an initial public offering once it has reached a stage of its growth and is confident that it can comply with regulatory obligations. IPOs help companies garner funds for their expansion plans, such as building infrastructure, hiring employees, foraying into new markets, etc.

Though IPO offers investors a chance to partake in the company’s growth and profits, you must do proper research to understand if a particular offer is worth investing in. This blog post will fill you in on everything you need to know before investing in an IPO. Let’s dig in.

Different types of IPOs

Generally, there are two types of IPOs. We will discuss them in detail.

Fixed-price issue

In a fixed-price offering, the company and its analysts evaluate the bids’ pricing. They judge the company’s resources, responsibilities, and every aspect of its economic situation before deciding on IPO pricing. Essentially, the company sets a fixed price at which the shares will be issued to investors. The advantage for investors is that they know the fixed price while subscribing to the issue.

Book building issue

Unlike fixed-price issue, the IPO price is not fixed. A book-building issue has a pricing range rather than a fixed price. Basically, there are two different price bands. “Floor price” refers to the lowest price band, while “cap price” refers to the highest price band. Investors who wish to buy can bid for the shares, adhering to the price band. The company sets the final price based on the bids it receives.

A company can opt for the fixed price issue, a book-building issue, or a mix of the two to conduct an IPO.

Pros and cons of investing in IPOs:

Pros of investing in IPOs

Capital access

IPOs allow firms to raise money from institutional investors who, in certain cases, are not permitted to invest in them as venture capitalists or angel investors due to legal and regulatory restrictions imposed by securities legislation. Moreover, publicly listed corporations have access to funds that would not otherwise be available because these exchanges are open markets and have access to many investors through brokers/dealers and other financial intermediaries.

Increased recognition

The company’s standing in the community rises. As a publicly listed firm is more noticeable, there is a significant likelihood that lenders will favor them over privately-held businesses.

More flexibility

Investors trade shares on an exchange after firms go public. As a result, there is greater diversity among investors as no one shareholder holds a majority of the company’s outstanding shares. Shares in publicly traded companies enable investment portfolios to diversify.

Higher returns

IPO offers you the chance to buy equity shares of a company at the lowest price obtainable. Stock prices can soar just after the firm goes public, allowing you to make big profits immediately.

Cons of investing in IPOs

Higher marketing and accounting costs

Initial public offerings are very expensive. The astronomically expensive underwriter fees are one of the biggest expenses associated with IPOs. If a business chooses to cooperate with a financial reporting adviser or other specialist organizations, the transaction costs will rise even more.

More administrative work

Investing in an IPO requires a lot of managerial work.

Time-consuming

You must research the company properly before participating in an IPO. Although all information is provided in the IPO prospectus, comprehending it requires effort and time.

Why should you invest in IPOs?

1. A majority of IPOs provide a discount to retail investors. Companies may offer shares at a discount to ordinary investors. You already have a benefit if you are applying under the retail quota.
2. If you invest in a solid IPO, you have a decent chance of seeing your wealth increase along with the firm. While it might not happen right away, it is likely that you will reap profits iof you keep the shares for a while.
3. When a person purchases and sells shares on the secondary market, the money goes toward financing productive allocation. An IPO may often assist an entrepreneur in raising capital for the company.

Conclusion

Don’t get carried away by the media hype if you plan to invest in an IPO. Make sure you do your own research. Before you desire to participate in an IPO, always refer to the issuing company’s preliminary prospectus, sometimes known as the Red Herring Prospectus.

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