An Initial Public Offering is the process of offering shares of a private or closely held public company to the public in a new stock issuance. An IPO helps a company to raise capital from public investors. The transition from a private or closely held public company or to a public company is an important time for private investors to fully realize gains from their investment as it usually includes a share premium for current private investors. It also allows public investors to participate in the IPO
Steps to an IPO
Proposals Underwriters present proposals and valuations discussing their services, the best type of security to issue, offering price, number of shares, and time period for the market offering.
Underwriter The company chooses its underwriters and officially agrees to underwrite terms through some underwriting agreement.
Team IPO teams comprises of underwriters, lawyers, CFA, Lead Book Running Managers , SEBI, Market Experts etc
Documentation Information regarding the company is compiled for required IPO documentation. Two parts, the prospectus and the privately held filing information.
Marketing & Updates Marketing materials are created for pre-marketing of the upcoming stock issuance. Underwriters and executives market the share issuance to demand and establish a final offering price. Underwriters make revisions to their financial analysis throughout the marketing process. This can include changing the IPO price or issuance date when appropriate Companies must take the necessary steps to meet specific public share offering requirements. Companies adhere to both exchange listing requirements and SEBI requirements for public companies.
Board & Processes Form a board of directors and make sure processes for reporting auditable financial and accounting information every quarter.
Shares Issued The company issues shares on a specific IPO date. Capital from the primary issuance to is recorded as cash and recorded as stockholders’ equity on the balance sheet. The balance sheet share value becomes dependent on the company’s stockholders’ equity per share valuation comprehensively.
Post IPO Some post-IPO provisions might be instituted. Underwriters usually have a specified time frame to buy an additional amount of shares after the Initial Public Offering (IPO) date. Meanwhile, certain investors are subject to quiet periods.
Pros • Raises additional funds in the future in the form of secondary offerings • Attracts and retains better management and skilled employees by offering liquid stock equity participation (e.g. ESOPs) • IPOs usually give a company a lower cost of capital for both equity and debt
Cons • Massive legal, accounting, and marketing costs arise • Increases time, effort, and attention required of management for reporting • Loss of control • Stronger agency problems
Things to understand before investing in an IPO
• Understand the business of the company
Before one invests in an IPO, one should be aware the kind of business the company is engaged in. One should ideally prefer such companies which are into a business that has a very high growth potential. A high-growth business allows the company to make consistent profits and increase its revenue
• Check past records, including promoter and management background
Checking the past performance of the company who’s IPO one have shortlisted helps in better understanding its business model. The company’s promoters need to be experienced and efficient in driving the company towards new heights.
• Analyse key financial parameters to assess the growth potential
For example, knowing the company’s debt-equity ratio helps you assess the company’s degree of leverage. A high debt-equity ratio usually indicates a higher risk in a company. Similarly, you may analyse the company’s earnings per share (EPS), cash flow, return on capital employed, and other key financial ratios before deciding to invest in it
• Compare with the peer group
Comparing a company with its peer group is one of the good ways to analyse an IPO.
• Learn about the risk factors
. To know about risks, you should read its Draft Red Herring Prospectus (DRHP). Companies mention all risk factors that may impact their businesses in the DRHP. It includes litigation, contingent liabilities, and the possible threats which may impact its normal business operations.
• Get clarity on your investment purpose
investing in an IPO for listing gains may not be a bad idea, but it should not be the sole purpose to invest in it.
