Initial Public Offering (IPO): Meaning, Process, History, Concept

IPO Stands for Initial Public Offering. When a private company listed for the first time and going to introduce its shares in the market, is known as Initial Public Offering (IPO). After releasing the shares in the market, the company is no more private, it becomes public as the public or the local investors have also invested their money in the company. In other words, An Initial Public Offering (IPO) is the process of offering shares of a private organization to the public. Public share issuance enables a company to raise capital from investors in public and also allows public investors to get involved in offerings.

History of Initial Public Offering (IPO)

The word Initial Public Offering (IPO) had been buzzed on the streets and from investors for many decades. The Dutch East India Company introduced their “First Modern IPO” by issuing their shares to the local public and was credited by the huge amount of profit from their IPOs. Since then, many companies had start-up using the idea of issuing their shares to the public as a way to raise their capital funds through public investors or from markets.

Though the years passed, many companies get involved in this kind of trading as they found quick profit-making. “AT&T” which is an American Mobile Service Provider Company all over the world, when due to some circumstances, at a period the company somehow lose its dignity in the market due to having loss then, unfortunately, they quickly introduced their IPOs to the market and consequently, got the huge success in the field of trade and stock markets.

As a result, the company had raised ‘360 million’ from its funding in IPO. Hence, we can see that the Initial Public Offering (IPO) has been used to raised capital, helps in the growth of the firm, managing to clear the company’s debts for many years. It has been used as a tool to raise a company as well as being beneficial to the public in general.

Concepts of IPO

To clear the concept of Initial Public Offering (IPO) let’s take an example, Assume that a company has a value of 50 crores, but his owner wants to take that company on an international level, and in this process, he has to invest 25 crores more on his company. Though, what he can do is! Either he can take a loan from any firm but this process is quite risk-taking for him and his company because he has to provide higher returns and interest rate as well and if he will fail to clear his debts, how he can manage to clear it off?

So, better what he can do is! He can list his company in the share market and release the IPO of his company. So that he can get the money easily to invest in his company directly from the local markets or the public and investors.

Underwriters of IPO

There are 2 parts of an Initial Public Offering- the Pre-marketing phase and Initial Public Offering. If any company shows interest in IPO, it has to advertise to underwriters by soliciting bids or make a public statement to generate interest. The IPO Process is led by the underwriters and is chosen by the company itself. There can be more than one underwriter choose by the company to manage different parts of the IPO process. The underwriters are responsible for due diligence, document preparation, marketing, filing, and issuance.

Initial Public Offering Process

The following steps are involved in the IPO process-

1. The Proposals and Valuations are presented by the Underwriters which discuss their services, the best types of security to issue, amount of shares, offering price, and time frame for the market offering.
2. Company and underwrites sign an underwriting agreement, if the company agrees to all the terms and conditions.
3. An IPO team comprise of Lawyers, Underwriters, Certified Public Accountants, and Security and exchange commission experts.
4. The company’s information is compiled to prepare documents for IPO.
   The primary IPO document for Filing IPO is the S-1 Registration. S-1 Registration has 2 parts- one is the prospectus and the second is the privately held filing information. S-1 also includes the expected filing date. The prospectus and the filing information are revised throughout the pre-IPO process.
5. The marketing materials are created. The purpose of creating the market material is the pre-marketing of new stock issuance.
6. A board of Directors needs to be formed at this step.
7. Process of reposting auditable information finance and accounts every quarter should be ensured.
8. On the arrival of an IPO date, the company issues its shares.
9. Some of the Post IPO Provisions can be included.

• Underwrites can have a time frame for buying an additional amount of shares after the IPO Date.
• Some investors may be subjected to quiet period.

Advantages of Purchasing Initial Public Offering (IPO)

The main aim of IPO is raising capital for business with some advantages. The Advantages of IPO are-

1. When a new company lists their IPO and releases their shares in the market so, you can buy it immediately at a very cheaper rate and after some time, you will realize those shares at 2-3 times higher amount than before generally. Therefore, you can earn by investments in an IPO easily.
   Example- A Company named “Happiest Minds” issues their IPOs on 17th Sept. 2020, at the price of INR 166 approx. and after 10 days, means on 28th Sept 2020 the price of the IPO becomes INR 363 approx. This shows rapid growth in investing in an IPO is more than two times in a short period of time.
2. There is Price Transparency in buying an IPO. As the price of the shares, a person buys from a company has been written on the Order Document of the IPO. Hence, the small investors, as well as the big investors, have the same information about their IPOs.
3. Whenever a company releases an IPO, there may be two reasons! If they have to pay their debts off or they want to expand their company at a high ratio. So, we can see that a company that is listing itself in IPO has more chances of growth in their near future, and there is less risk of loss and a higher possibility of gaining profits.
4. IPO provides a lower cost of capital and equity to the companies.
5. The Liquid stock equity Participation (such as ESOPs) enables public companies to attract and retain good management and skilled employees.
6. The IPO helps in building the company’s image, prestige, and exposure which leads to increased sales and profits.

Disadvantages of Purchasing Initial Public Offering (IPO)

1. A company that is providing the IPO is more expensive as compare to other companies.
2. The company has to disclose all its financial secrets and other information as well, to maintain transparency in business but this may lead to help their competitors to reveal their secrets.
3. This may lead to an increase in the company’s time, work, efforts, and pressure in reporting of the management.
4. If the market, unfortunately, does not accept the price of an IPO then this may lead to the risk requires in funding may not raise.

How To Invest in Initial Public Offering (IPO)

1. To invest in an IPO, first of all, a person has to open a ‘Demat Account’ which is compulsory to every buyer when they start online trade.
2. After opening the Demat Account in your mobile application, you can choose one from any two options, which is either through UPI or you can choose The Net banking.
3. If a person chooses to apply through UPI, then he/she can go for the mobile applications or websites of the brokerage firm. There the buyer can create their trading account and can choose the IPO of his/her own choice in which they are interested to invest their money.
4. The buyer cannot choose a single piece of share in IPO. He/she must take the shares in terms of quantity. Likewise, 27 shares, 40 shares, or more. This is the common condition for every firm when they introduce their shares to the public.
5. Then a buyer have to select the price at which they want to apply for its IPO.
6. After that, a buyer have to fill up the application form with its UPI ID and approve it, block funds on it, and then it’s all done.

Initial Public Offering (IPO): Grey Market

There are three markets in Initial Public Offering (IPO).

1. White Market: This is the Official Market of IPO, in which we can buy or sell the share and can also exchange the stocks. It is regulated by SEBI.
2. Black Market: It is Non-Official trading of IPO. The SEBI has controlled a lot in these kinds of markets to avoid malfunctioning in IPO trade.
3. Grey Market: The Grey Market Premium is not completely illegal but, it is Unofficial. In other words, It is not regulated by SEBI. This is run by specific individuals or any other private firm. Example: A company before releasing their shares in the market, offers them to their employees and so, they can sell them to someone else. Perhaps, this can make an idea that how much response they can gain in the market after releasing their IPOs and this is known as Grey Market. This is usually used to get an idea about their respective IPO in public.

Some Terms Related to IPO

The main terms related to IPO are:

1. Direct Listing

When an IPO is conducted without the involvement of any underwriters, it is called Direct Listing. In this process, The issuers are prone to high risk if the offering does not do well but can be benefitted from a higher share price. If a company has a recognized brand and attractive business, Direct Listing can be beneficial for them.

2. Dutch Auction

The IPO price is not fixed under Dutch Auction. The buyers can bid for the desired shares and prices they are willing to pay and the shares are allocated to the higher bidding buyer. Alphabet (GOOG) conducted IPO through Dutch Auction in 2004 and many other companies like IBKR, MORN, etc prefer to conduct the Dutch Auction rather than the traditional IPO.

Performance of an IPO

There are many factors involved that can affect the return from an IPO and investors are required to watch closely. IPO is well-known for gaining in short-term trading. There are some considerations for IPO Performance:

• Lock-up: Lock-up agreements are the legal bidding contracts between the underwriter and company insiders which prohibit them from selling any shares of stock for a certain time period. The time period can vary from 3 months to 24 months. Under Rule 144 (SEC LAW), the minimum lock-up period is 90 days. After the expiration of the Lock-up Period, all the insiders are free to sell stocks which leads to a rush of people selling their stocks and end up putting downward pressure on the stock price.
• Waiting Period: Few investment banks include a waiting period in offering terms under which they set aside some share for purchase after a certain period. If the underwriters are allocated, the price may increase otherwise it can decrease.
• Flipping: Flipping is done when the stock is discounted and soars on the very first day of trading. It enables the reselling of an IPO stock during the starting few days to earn a quick profit.
• Tracking Stocks: By creating Tracking Stocks, an existing company spins off a part of its business as a standalone entity. The reason behind this step is that in some cases the separate parts of the business can be worth more than a combined business.

Frequently Asked Questions

Q1. What is the main reason for Initial Public Offering (IPO) to introduce in markets?

Ans. An IPO is generally used by large companies as a fundraising method through which they can sell their shares to the public. Some of the main reasons for undertaking an IPO are: To raise capital from the shares the company sells, to provide liquidity, and to help the company in the clearance of their debts easily.

Q2. Who can invest in Initial Public Offering (IPO) or can anyone invest in IPO?

Ans. Yes, anyone can invest in IPO but often sometimes, when the new IPO is in more demand than the supply, due to this reason, there will be no guarantee that everyone who is participating in the IPO can purchase the shares they are willing to buy. Although investing in IPO can be sometimes limited.

Q3. Is it Risk-taking to buy Initial Public Offering (IPOs) shares from the private firms?

Ans. The large companies which issue the IPO tend to seek a lot of media attention before going to publicize their shares. Hence, we can say that this is occasionally producing huge gains in a short period of time. In most cases, they can provide large losses as well. Perhaps, A investor should judge the IPO according to the company’s prospectus as well as an investor must be financially stable to tolerate the high and low risks they may get while investing in IPO.

Q4. What is ‘Flipping’ in terms of Initial Public Offering (IPO)?

Ans. To resale, the stock of IPO within the first few days to gain more profit from its share is termed as flipping in Initial Public Offering (IPO).

Q5. State the names of the largest Initial Public Offering (IPO) in the world.

Ans. The largest IPO in the world are:

• In 2006, the company named ‘American Insurance Group’ (AIG) had raised its funds to 20.5 billion dollars.
• In the year 2008, ‘VISA’ (V) had raised 19.7 billion dollars from its IPO.
• In the year 2010, The Company ‘General Motors (GM) had raised 18.15 billion dollars from its funds.
• The most popularly known and used mobile application company ‘Facebook’ (FB) had raised its funds to 16.01 billion dollars in the year 2012.
• In 2014, Alibaba Group (BABA) had raised its fund up to 25 billion through IPOs.

Read Also: SEBI; Securities and Exchange Board of India