Understand what is an IPO: The recent announcement of LIC’s IPO has attracted attention throughout the country. Investors will be keen to own a stake in the largest insurance company in India. This IPO will also generate an interest in beginner investors.
Would you like to know what exactly an IPO is? Read more to find out. Today we’re going to talk about the basic features of an IPO and how it creates capital for newly listed companies.
An IPO is an Initial Public Offering – It is the first time a private company lists its shares on a listed stock exchange and becomes public.
This allows the general public to invest in its shares and become a part owner of a newly listed company. In return, the firm will aim to maximize the capital invested through the listing and also provide a moderate to high rate of return to its initial investors.
What is an IPO: How Does an IPO Work?
Generally, an IPO is a hectic process, involving a number of financial factors that come into play. The Private Company looking to go public usually hires an Investment bank or financial firm to assist in the IPO, setting issue price and underwriting.
Once the issue price has been decided after advice, the investment bank notifies potential investors of the IPO which will be listed on an important stock exchange such as the BSE or NSE.
DRHP – Draft Red Herring Prospectus
When a company decides to list itself on a public exchange, a document called DRHP has to be submitted to the regulatory body. In India, the regulator is SEBI and this is also called an offer document.
This document communicates to potential investors about the company which is crucial to making an informed decision. An entire overview of the company is provided in the prospectus. It provides viability for going public and raising capital from potential investors.
A key factor of an IPO, apart from the company itself, is its underwriters. An underwriter is a mediator between the company and potential investors. Other important tasks include issue price analysis, total capital to be raised, valuation of the company, etc.
Underwriters also have a risk agreement with the company, agreeing to purchase the shares in the IPO and issue it to the public.
A share lot is a unit of shares that can be bought in one transaction. This term is important to remember in the case of IPOs. Generally, when issuing shares for the first time, every investor can only invest if they buy a minimum lot of shares.
What is an IPO: Why do Companies Decide to go Public?
There are many reasons why a private company decides to go public. One crucial reason is that the promoters of the company want to liquefy their investment in the company.
Some significant reasons are –
1. Raising Capital
One of the main reasons for a company going public is to raise capital in the form of shares. These shares are issued out to the public at a predetermined issue price. This method of raising capital for a newly listed company is cost-effective compared to VC firms and private investors who would seek a larger stake or higher returns.
2. Offer For Sale
Angel Investors, Venture Capital firms, close friends, and family would seek to sell their stake in the company for a higher return on their investment. By selling their stake, they are also mitigating the risk associated with the company.
3. Benefits of Listing on an Exchange
Before officially being listed, a private company makes headlines and gains publicity, creating an interest in the company before its actual public listing. This in turn creates a demand for its shares before the IPO and provides a higher valuation.
What is an IPO: How to Invest in an IPO?
Investing in an IPO is different from regular day trading and investing. There is a certain criterion that an investor has to fulfill to purchase the shares of an IPO. Usually, this is done through a stock broker or investment firm as they are newly listed.
Depending upon the marketing done before the actual listing, there are higher chances that demand will be significantly higher than supply so buying shares at an IPO is fairly difficult.
What is an IPO: What is the Risk Factor of an IPO?
IPOs sound attractive to a majority of the public, but they are also associated with a higher rate of risk. One of the main reasons is the lack of history and performance data of the company, unlike established companies in the exchange.
More than 60% of IPOs listed between 1975 and 2011 declared negative returns. So there are chances of growing your investment multifold or falling lower than its initial issue price.
An IPO is a great opportunity to increase your wealth and own a stake in a newly listed company. To the general public, it opens a new investment avenue that happens only once in a company’s lifetime. In parallel, they are also associated with a higher risk as the past performance of the company is uncertain.
Making an informed decision is key to achieving capital gains. Do let us know your opinions in the comments below and share if you found this article valuable.
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