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What is IPO – Introduction, Meaning, Pros & Cons

Introduction to IPOs

Stock market is one of the most lucrative investment avenues in India. People invest in the stock market because it has the potential to generate handsome returns in a small span of time. Investors trade in the stock market either through the primary market or through the secondary market. The primary market involves investing in the stock market by applying to the Initial Public Offering (IPO) of a company while the secondary market involves purchasing and selling shares directly from the stock exchange. This article, will walk you through the details of what is IPO, its concept and everything related to it.

Let us begin by understanding IPO meaning.


Understanding Initial Public Offering / IPO Definition


IPO stands for Initial Public Offering. It is the process by which a private company can go public by selling its shares to the public. The company bringing it can be a new company or an old company. With Initial Public Offering, the company gets its shares listed on the stock exchange.

Companies float it to raise funds by issuing new shares to the public. However, the existing shareholders can also sell their holding to the public without the issue of fresh capital.

Let us now learn about IPO details and understand the process through which the company brings it.


Process of IPO

The first thing that a company does before bringing an IPO is to hire a merchant banker to handle the process. An underwriting agreement is entered between the merchant banker and the company to work out the various financial details of the IPO. The merchant banker underwrites the shares of the company by buying all or some part of the shares and sells it to the public. Later, both the parties file registration statement with the Securities and Exchange Board of India (SEBI) along with the underwriting agreement and necessary documents. SEBI then goes through the details of the statement submitted to it and if the information submitted is found correct, it allots a date to the company to announce its Initial Public Offering.

The initial listing fee of the company is Rs. 50,000 and depending upon the paid-up share capital of the company the subsequent annual listing fee is determined. The company determines the price band of the shares and the merchant banker offers its shares to the public. Many roadshows and awareness advertisements are done to generate interest among the public to subscribe to the shares of the company.

Let us now understand the various reasons why a company floats an IPO.


Reasons for floating an IPO

● The main purpose of floating it is to raise money. Companies are in constant need of funds to expand, upgrade or repay their loans. Depending upon the requirements, a company floats it to raise funds.
● Through an Initial Public Offering, the shares of the company list on the stock exchange. This increases the liquidity of stocks which promotes various employee stock ownership plans.
● By going public, the credibility and brand value of the company increases. The name of the company being flashed on the stock exchanges is a matter of pride for the company.
● When the demand in the market is more, the company can issue higher number of stocks. This opens the door for the company for mergers and acquisitions as the stocks can be issued in exchange for the deal.

The above-mentioned are the reasons why a company floats an initial public offering, let us know about the various checks you must do before investing in a company’s offerings.


Things To Do Before Investing in an IPO

● Check Company’s Background
Since the company is coming up with its Initial Public Offering, often there won't be any historical data available to check your decision about investing in the company. However, the company floating it does provide a prospectus. You must carefully scrutinise and read all the details provided in it before arriving at any decision about investing in the company.

● Check the Underwriters
The success of the IPO depends upon the big broker who is endorsing the new issue. If the underwriters are well established then you may look at investing in such offerings.

● Lock-in Period
Before applying for an IPO, you must read the contractual obligation of the company’s executives and investors about the lock-in period of their shareholding. Often, the prices of shares drop drastically after the company completes the offerings as the shareholders of the company sell their shares in the open market once the lock-in period ends.

The above points will help you in taking the right decision about investing in an IPO. Let us now read about the points that you must be aware of before investing in them.


Points to Remember Before Investing in an IPO

● When you invest in an IPO, you invest in the business of the company. The long term returns on the shares allotted to you will depend on the fortune and performance of the company.
● The stock market is subject to volatility. Investing in Initial Public Offering can reward you with unbelievably high returns but at the same time, they also have the potential to erode the invested capital so be vigilant while investing.
● While applying for it, you must be aware of the fact that the company is not liable to public investors to reimburse the capital.
Therefore, while investing, you must be aware of the potential risks and rewards. Let us now read about the advantages and disadvantages of an IPO.


Advantages of an IPO
● The biggest advantage of an IPO is that it fulfills the financial needs of the company. It is an easy option to acquire capital for its growth and fund a massive expansion. With it, the company can invest in infrastructure and acquire new equipment. It also helps in paying off its debts.
● With Initial Public Offering, the shares of the companies are available for mergers and acquisitions. Also if the company wants to acquire any other company, the shares of the company can act as a means of payment.
● It attracts talented employees because the company can offer them many stock options and hire them at relatively lower wages.
● The owners of the company get the reward of their hard work by listing their company on the stock exchange. In the IPO, they can get for themselves a certain percentage of shares in the company and enjoy the prestige of being a listed company.


Disadvantages of an IPO
● IPO is a long process and it requires a lot of legal compliances. This distracts the company from its core business and can dent the company's profits. Also, companies are required to hire merchant bankers to ease the process of IPO and in return, they charge hefty fees.
● In many cases, the business owners are not able to take as many shares for themselves. Many a times they may not be able to sell their shares in the market due to the lock-in period. Therefore, the business owners are sometimes at a loss when they float an IPO.
● Securities and Exchange Board of India (SEBI) conducts many checks before a company floats an Initial Public Offering. This process can be time consuming and requires huge disclosures. Besides, the promoters are required to submit details that may be used by competition and can hamper their business.


Conclusion

The above mentioned article will help you learn about IPO right from what it means to how to invest in them and what are the risks and benefits associated with investing in them.

Investing in newly launched public companies can be extremely rewarding. However, you must also know that it can be risky and at the same time profits are not guaranteed.

Having said that, over the years, Initial Public Offerings have offered good returns to investors. You may consider investing in it after researching about the company and its management. Every month a lot of IPOs list on the stock exchange, all you have to do is find the companies with higher potential and invest in them. Remember, an informed investor always performs better than one who is not.

 


Disclaimer: Investment in securities market / Mutual Funds are subject to market risks, read all the related documents carefully before investing.