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What is an IPO? Why Do Companies Go Public?

What is an IPO?

The IPO is a company’s first sale of shares to the general public, institutional investors, and high-net-worth individuals (HNIs). As the companies opting for the IPO seek to raise long-term capital, the classification of the IPO market is a primary market. A company willing to enlist on the National Stock Exchange (NSE) or the Bombay Stock Exchange (BSE) must have a minimum paid-up capital of ₹ 10 crores.  

The traders and investors benefit as they get to own a part of the company and can sell their shares when their value rises and they earn a profit. An IPO also represents a significant shift in its operations, for it is no longer a private company but requires publishing quarterly and annual financial reports. 

Understanding Technical Jargons

Before we jump on to how IPOs work, let us understand a few technical terms used when talking about IPOs.

Preliminary Prospectus

Also known as the Red Herring Prospectus, companies need to submit this document to the market regulator SEBI when they plan to raise funds through an IPO. The document contains its business operations, financials, and promoters, stating how it intends to utilize the raised money and the possible risks to investors.

Price Band

The price band represents the highest and lowest price the seller is willing to sell at. During the launch, this is the price at which the buyer bids.

Issue Price

The price at which the company first offers its shares to the general public is the issue price.

Common Stock

Common stock describes an investor’s ownership of a company. It allows you to select its board of directors and extends their voting rights to participate in corporate policy making. 

Shareholder Category

Certain companies reserve a specific portion of the IPO for the existing shareholders, known as the ‘shareholder category’. The chances of getting an allotment under this category are higher than the retail investors. 

How Does an IPO Work?

A company hires a merchant banker to guide it through IPO to go public. This is similar to how your mortgage lender underwrites your loan to ensure it is a good deal for you and the bank. 

The merchant bank then proceeds to sell the company’s shares to a vast public. By selling to many people, they raise capital and diversify risk while presenting prospective buyers with the company’s financial information and asking price.

Investors place bids indicating how many shares they wish to purchase. Various factors, including the company’s value and existing market conditions, determine their price.

Why Do Companies Get Listed on the Stock Exchange?

Listing a company on the stock exchange is tedious and expensive. Also, a company must have a detailed five-year business plan to let the investors know what to expect from their investment. Moreover, investors only invest after comparing you with your competitor. 

Despite the troubles of listing on the stock exchange, companies continue to do so because of the numerous benefits. The stock exchange promotes transparency in trading listed securities under perfect equality and competitiveness.

Fund Raising Channel to Companies 

Corporates and entrepreneurs can use the listing to raise capital to fund new projects, expand/diversify their businesses, and make acquisitions. 

Exit Route to Investors

The listing also provides an exit strategy for private equity investors and liquidity for employees’ ESOP (Employee Stock Option Plans) holdings.

Security’s Ready Marketability

Continuously, a securities listing adds prestige and importance to the companies by bringing in liquidity and ready marketability of securities.

Transparency

The listing agreement signed with the exchange requires the company to provide timely disclosure of information relating to dividends, bonuses, rights issues, book closure, transfer facilities, company-related information, and so on, providing increased transparency and encouraging investor confidence.

Securities Collateral Value

Lenders accept listed securities as collateral for credit facilities. Capital lenders give a favourable rating to listed companies, making it easy for them to borrow from financial institutions; the company can also raise additional funds from the public through the new issue and enter the stock market with a higher degree of assurance.

IPO Return on Investment

If you want to invest in a small company, the IPO price is often the best deal, and this is due to the possibility of the company offering a discounted rate. If you miss the IPO window, investing in that company may be difficult because the stock price may skyrocket. However, there are often scenarios where the markets treats a debutant as overvalued, and investors may end up losing a fair share of initial investment in the initial trading period. Hence, it is advisable that investors do their due diligence, and go through the detailed DRHP (Draft Red Herring Prospectus), before making any investment decisions into an IPO.

Top Five Current Gains in India

as of 3rd April 2022

Date of IssueIPO NameCurrent Gains
16-Feb-22Vedant Fashions20.95%
08-Feb-22Adani Wilmar178.11%
31-Jan-22AGS Transact35.80%
31-12-21CMS Info System23.36%
28-12-21Supriya Lifesci81.99%

Conclusion

IPOs provide some of the most significant opportunities for wealth creation, and some newcomers have the potential to make a huge impact and change the situation to better and increase high-revenue earning positions. 

However, it is necessary to mention that not all IPOs are successful and can vanish without a trace. You should carefully study the company, its financial strength, and its operations before investing.At WealthDesk, we offer you readymade WealthBaskets consisting of stocks or ETFs reflecting an investment strategy or theme designed explicitly by the SEBI-approved investment professionals and make your investment journey hassle-free.

FAQs

What is the need for an Initial Public Offering (IPO)?

An IPO is the first time a company sells its stock to the general public. Following an IPO, the company’s shares trade on a stock exchange. Raising capital and taking advantage of a higher valuation are two primary reasons for launching an IPO.

Can anybody invest in an IPO?

Yes, investors who want to take part in an IPO may be able to do so through their Demat account. 

Who gets the money from an IPO?

Companies often raise capital via IPO to fund future expansion and working capital requirements. Here, the company directly takes the proceeds and uses the same as mentioned in their DRHP. 

However, in an IPO, existing investors may participate in a stake sale and take a full/partial exit. In such a case, the stake sale amount goes to the investors once the process is complete.

Is it good to invest in IPOs?

Many investors make a lot of money by applying for share allotment through an IPO and holding it for the long term, however, if things go worse, you may lose money as well. 

What is an IPO? Why Do Companies Go Public?

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What is an IPO? Why Do Companies Go Public?

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