When investors are introduced to the world of capital markets for the first time, they usually come across several market terminologies that may seem difficult initially to comprehend. However, with some effort and simple research, one can get started with learning the basics. Initial Public Offering (IPO), is one such essential term investors need to familiarize themselves with, before foraying into stock market investing. Several established organizations and enterprises have achieved great things after launching their IPOs on major market indices like BSE Sensex, NASDAQ 100, NYSE, etc. By listing their shares on the stock market, they expect retail investors to verify the standing of the company and make investments accordingly.
For companies that have achieved a certain amount of success during their years of operation, launching an IPO and going public is often the next best thing to pursue, and expand their operations. By offering shares, they will be able to raise capital that they might not possess at the time. Apart from bringing more liquidity, it allows them to settle debts and even improve the public perception of the company. There are several sequential and crucial procedures involved before an IPO launch, and companies have to fulfill them to receive relevant approvals.
The relevance of IPO for organizations and the steps involved
Companies are co-owned by their founders and investors, who often elevate the organization to a confident position. The decision to open up the company’s shares to the public through an IPO is based on the confidence gained after years of good performance. There are several reasons beyond the influx of new money, and one of them pertains to paying off loans. Many enterprises rely on bank loans for funding, and after steady performance, repayment of debt is a top priority. Keeping the accounting books positive with money raised through sold shares allows them the flexibility to invest in their future. For instance, in sectors like IT and manufacturing, putting money in new technologies and research, hiring experienced candidates, or upgrading infrastructure takes immediate precedence.
In terms of the procedures, companies have to first hire an investment bank for underwriting, as they usually determine how much the initial share price must be. They evaluate the amount of capital the company wishes to raise and what portion of shares need to be sold to achieve their targets. Subsequently, companies must build a red herring prospectus (RHP), which is a 360-degree profile of the company that defines their performance journey, long-term plans, and standing in the industry, among others. It is followed by the submission of the RHP to regulatory bodies which oversee the approvals and other launch formalities for the IPO. In India’s case, the Securities & Exchange Board of India (SEBI) takes up the responsibility of verifying the documentation and communicating their approval. It is then taken to major market indices like BSE for formalization and authentication. The IPO then gets listed and allotment of shares to investors takes place based on first movers’ advantage.
Benefits of IPO for investors and necessary steps before investing
Investors need to constantly monitor market developments and be among the first movers to make the most of the offering. Usually, the share prices are pegged at a bare minimum value, and those who are quick to buy-in, are more likely to generate higher returns. The share value often goes up once they get traded on the secondary market. The ideal way to approach the issue would be to identify if the IPO is coming from a company that is recognizable, or has garnered respect in the industry they are operating in. For example, if a firm is known for innovating and disrupting the economy with next-gen products and services, it would be perfect to bet on, considering the prospects for growth. However, there are instances when well-performing companies fail. To prepare yourself for such scenarios, special efforts are needed to carefully analyze the RHP before taking investment decisions. Only when you understand the pros and cons of the company, can he/she make the best possible assumptions of its prospects.
In other cases, companies may not show immediate returns, and offer a stable growth trajectory over a longer duration like five to ten years instead. Investing in them could prove to be advantageous, provided they hold a commendable record of growth and sound management practices. On the flip side, companies stand to gain reputation and respect, as the public tends to retain the news on performing assets. It is prudent that companies diversify their funding options, be it through bank loans, new investors, mergers & acquisitions, and selling a portion of their shares through an IPO. It helps companies plan a better growth strategy and bring the best brains onboard.