The abbreviation of IPO is Initial Public Offering, also called a stock launch. A stock launch is a public offering where a company share is sold to institutional and retail investors. It is an important event for the company and it is raising the capital fund. Investment banks underwrite IPO for fundraising from the public.
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What is underwritten?
Underwritten is the process of providing services to the company that guarantees the price value of securities. Investment Bank makes an agreement with the company for selling several stocks to the public. An underwriter acts as a middleman between the company which is going to be public and investors who are all ready to buy the stocks from that company.
Underwriters or Investment banks purchased the securities from the company at a fixed price. If they cannot sell the securities to the public, then they hold it to themselves. They form a group or association of banks, they buy a portion of securities from the underwriter. And they resell the securities to the public. Before the IPO process, the payment to the underwriter is negotiated between the company and the underwriter based on the underwriter’s reputation, market demand for the stock, and the size of the IPO. The fee payment of the underwriter calculates by the percentage of the total amount of shares sold to the public.
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Advantages and Disadvantages of IPO
Advantages of IPO
- The first and foremost reason is fundraising which means raising the capital fund from the public for the company. And this fund is so helpful for the easy-to-scale growth of the company. Using this fund they create extensive better infrastructure and even hire more employees for their company.
- If your company issued the first stock sale on the public market, it turned from private to public.
- Before the IPO, company owners are family members and a small number of investors like friends and relatives. But after the IPO, company owners are a large number of investors. In starting, few people invest in the company but later it’s turning hundreds of thousands of shareholders.
- And Company gets listed on the stock exchange to attract top rich candidates to invest in their company.
Disadvantages Of IPO
- Once companies have come to the open public market they must be under control by stock exchange regulators.
- And the company must answer all its shareholders. If you do not satisfy the shareholders, you may be fired.
- Stock exchange regulatory necessities cost is very high for small companies. And the price increased with the occurrence of the Sarbanes Oxley act. Additionally included the cost of financial documents, audit fees, and financial account management.
IPO Process
1. Selection of the Right Underwriter
To select lead and high reputation underwriter for providing underwriting service. They advise and help to create organization registration statements. And they are responsible for underwriting syndicates and making an initial draft of an agreement between the investment bank and the company. Before you choose an underwriter, analyze the past relationships with the bank.
2. Due Diligence Filings
It is the investigation process and the underwriter does it in 60 days. If you invest a significant amount in the company, then your company needs Due Diligence for all activities. It’s highly recommended. An underwriter must investigate all background details of the company which will give investors the confidence to purchase the newly listed company shares. He must analyze the company ownership details and financial management and check the company’s previous three years’ profit margin.
Pricing
A private company initially sells its shares to the public which is known as IPO Process. Before the IPO launching, the price of stocks which is going to be sold must be determined. The one crucial thing is the price of the stocks should be reasonable. If the company’s stock price is very high or low to the market price then the company faces a loss.
Once the stock price is determined, the company owners and underwriters decide the effective date of the IPO launch. There are two types of pricing methods in IPO.
- Fixed cost method — This method is used to value a company’s stock. which is based on the cost of capital and also must be needed to finance the company’s operation. Using this fixed-cost method, the price of the stock is determined. The IPO price is calculated under the fixed cost method. For example, if the company has expenses like rent, salaries, variable costs, raw material costs, wages, etc. To cover these costs it will mark up with the IPO Price. And the company owner will expect a certain profit margin in the share market. so they set an IPO price based on the expected profit margin.
- Book building method — This is the process that is used to determine the price of the stock that will issue to the public. The idea of the book-building method is created to mainly increase the IPO price and also based on the demand for stock in investors. Through a series of roadshows, advertisements, and presentations company attract potential investors. After getting orders from these potential investors, the bank and underwriters evaluate the demand for the stock from investors. Finally, they determine the IPO price based on that evaluation.
Stabilization
Once the stock has been launched, the underwriter supports the stock price. It is possible to the stock price may fall below the IPO price. The analyst needs to give some recommendations about the stock price. Finally, they have to create a market for that stock.
The underwriter can take only a short period for stabilization. In this short period, they have a right to trade and guide on the stock price.
Transition
This is the final stage of the IPO process. In this stage, the company shares are publicly available in the open share market. A private company converts into a publicly traded company. As a publicly traded company, they have to file their reports and disclosure requirements in the Securities and Exchange Board of India. They must adhere to the rules and regulations of the SEBI (Securities and Exchange Board of India). It is not an easy process and it is a time-consuming process from start to end. After a successful IPO process, they have to be transparent with the public. Their activities are always under scrutiny by the public and SEBI. Finally, the company’s stock is moving from price stabilization to market competition.