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Initial Public Offer (IPO) – What is it, Purpose, Advantages of IPO, FAQS

  • Akarshita Yaji
  • Feb 17 2022
  • 5 minutes
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An Initial Public Offer is a landmark event in the life of a company and every entrepreneur’s dream. It is a validation of the business model of the company along with the public trust and goodwill that the company has gained over the period of its operations. Want to understand more about IPOs? Then read on!

What is meant by IPO?

IPO or Initial Public Offer refers to the process of offering shares of a company to the public. The public in question involves all those individual and institutional investors who are interested in investing in the company.

What is the purpose of an IPO?

A company resorts to an initial public offering in order to raise capital from the public. It enables the company to access public money to grow and expand. It is also seen as an exit strategy for the company’s founders and investors. It helps them realise their profits.

How does an IPO Work?

A private company with well-established operations initially derives its funds from venture capitalists, angel investors, friends and family. However, when the company feels the need to obtain capital from the public to expand its operations or diversify its interest, it will begin to project its interest to go public. The company is to have a good valuation, strong fundamentals and proven profitability in order to make the IPO confidently.

The price of the shares will be determined through the underwriting process. Even the existing private shareholding becomes worth the public trading price and can be traded on the secondary market. In this pre-marketing phase, the company will either advertise to the underwriters to solicit private bids or will make a public statement to generate interest. 

When the IPO is completed and the company’s shares are listed, then it is understood that the securities are now admitted to the dealings on a recognized stock exchange.

When does a company decide to go for an IPO?

A company decides to go for an IPO in three main circumstances i.e. when it wishes to acquire, expand or diversify its operations. If the company needs finances for working capital or to retire old debt. This IPO acts as an invitation to offer – a precursor to a valid contract as per the Indian Contract Act. 

It is important to note that an unlisted company is eligible for a public issue if the net worth of the company is greater than rupees one crore in the past three years of the last five years. It is also important that there must be distributable profit for at least three out of the preceding five years.

What are the advantages of IPO?

When a company decides to opt-in for an IPO, it not only gets access to public money but the increased transparency associated with the process ensures that it is easier for them to get credit on more favorable terms. An IPO is a good way for the company to assess its market worth and the goodwill that the business has earned. It also provides the company with greater market visibility. Additionally, an IPO also offers liquidity to the existing shareholders allowing them to cash on their investments. 

What are the disadvantages of going Public?

When the company decides to go public there are several cons that they might be faced with. For instance, launching an IPO requires huge upfront costs such as underwriting charges, legal fees, advertising costs etc. There is a loss of autonomous control over the company as even the minority shareholders can influence the decision-making process. There is an increase in the compliance requirements.

What are the benefits that an investor derives through an IPO?

IPO is important to an investor for it is the first time that the investor gets to be a part of the growth story of the company that they believe in. If invested right, the investor gets to earn short-term and long-term gains out of the shares that are unaffected by market demand.

Frequently Asked Questions

  1. What are the main steps involved in going public or issuing an IPO?
    The company is to select a bank, complete all due diligence filings, price the shares of the company with the help of experts and underwriter, wait till the funds are stabilized and then transition into a public company.
  1. Who decides the date of the issue of the IPO?
    Once the draft prospectus of an IPO is cleared by SEBI, the date for issue of IPO will be decided by the company in consultation with the lead managers, the registrar of the issue and the stock exchange.
  1. What are the metrics to judge if an IPO is successful or not?
    In order to judge the success of the IPO one has to look into the market capitalization and see if it is equal to or greater than the industry competitors. One must also look into the market pricing i.e see if the offering price and the market capitalization post the IPO is less than 20% after thirty days of the issue.

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