IPO in Stock Market: What Is it? How Does It Work? Pros & Cons￼
An Initial Public Offering (IPO) offers people the chance to become investors in a company while allowing the company to raise a significant amount of capital. IPO is a time-consuming process involving underwriters, investment banks, registrars, investors, and brokers. Every one of them plays a vital part throughout the process of an IPO.
Let’s understand more about IPO’s in this blog.
What Is an IPO?
Initial Public Offering or IPO is the tool through which a private company gives out its shares to the masses for the first time. In return for giving ownership to its investors, the company raises capital and uses that amount to develop its business.
After its shares are listed on the stock exchange, the company becomes publicly owned, and its shares can be freely traded among investors. An IPO is vital for a business’s growth as it is often the largest source of funds companies can access.
What Are the Types of IPO?
There are two types of IPO. These are:
- Fixed Price Offering
In a fixed price issue, investors are well aware of the price of a share before the IPO process of the company begins. While subscribing to a company’s IPO, they need to pay the total fixed price for the applied shares.
- Book Building IPO
In book building process, price of the share is released during the process based on demand. Though the price is not fixed, a price band is released with the lower price being the ‘floor price’ and the higher price being the ‘cap price’.
In the book-building method, investors are required to bid for shares within a specific time before a company decides the price. The bidding takes place within the price band that can have a maximum limit of 20%. It is important for the company to inform the investors of the total number of shares it intends to offer, even though the final price is set based on the bids.
How Does an IPO work?
Before going public, a company appoints an investment bank to conduct the IPO. In the underwriting agreement, an investment bank and a company chalk out the IPO’s financial specifics.
After that, they submit the registration statement to the market regulator, SEBI (Securities and Exchange Board of India), together with their underwriting agreement. SEBI examines the disclosed information and, if confirmed accurately, approves a date for IPO announcement.
Once an IPO is done, shares are listed and ready to be traded in an open market.
What Are the Pros and Cons of Investing in an IPO?
There are various advantages and disadvantages of investing in an IPO. These are:
- Ownership: Once the shares are allocated, shareholders will get voting rights in the company’s annual meetings. Investors may also receive dividends from the company.
- Listing Profit: If shares open with a higher price than the offer price on listing day, investors can profit exponentially from it.
- Transparency: When launching the IPO, the issuer has to disclose all sorts of information, including its financials, legal issues, and competitive advantage. Moreover, this data is verified by the market regulator and stock exchanges.
- Early Opportunity: If the IPO shares skyrocket after listing, early investors will make massive profits with a relatively small investment. IPO shares are often offered at a discount to their market value, making them a good entry point.
- Shares May Be Over-valued: The stock market is filled with ups and downs. While investing in a share, you have to look out if it is overvalued or not. If a share becomes overvalued, its price will eventually fall down, causing losses for early investors.
- Little Assurance of Share Allotment: If a share is over-subscribed, there is little chance that the share will be allotted to you.
- Volatility Issue: On listing day, the share price may see massive movements. If the graph keeps falling sharply, this may lead to substantial losses for investors.
What Are the Pros and Cons of an IPO for the Company?
For a company offering an IPO, there are several advantages and disadvantages involved in the process. These are:
- Publicity: By going public, a company not only gains money from the public but also gains its trust. This builds the company’s reputation and brand image.
- Money-making: A company makes money by giving off its shares. This money can be used to repay debts or for the further development of the organisation.
- Exit Opportunity: An IPO provides an exit point for existing shareholders and promoters who have helped the company grow at its founding stage.
- Higher Cost: The entire IPO process includes lots of direct and indirect charges. From hiring an underwriter to getting listed, the entire process can cut a deep hole in the pocket of an organisation.
- Loss of Ownership: The CEO and MDs of the company lose their absolute authority as a new board of directors is appointed.
For companies, IPOs are a primary way of raising large capital and a tool to build credibility and trust among the public. For investors, these are unique opportunities to make profits in the secondary market.
When investing in an IPO, you will have to know when to invest, where to invest and how much to invest. You can gain high returns on your investment by doing proper research and following the market trends.
Frequently Asked Questions
Who can apply for an IPO?
A person having a Demat account with a minimum balance to bid can apply for an IPO.
Can a bidder revise their bid in an IPO?
Yes, investors in the retail category can withdraw, cancel or revise their bids in IPOs. But they must do so before the offer closing date.
What is the floor price in a book building IPO?
The floor price is the minimum price at which bids can be placed. There is also a cap price, the highest price for bids in a book-building issue.
Is it possible to enter bids less than the floor price in an IPO?
No, the system automatically rejects any bid which is lesser than an IPO’s floor price.