IPO Meaning

In the world of finance, going public refers to the process where a business offers securities for sale to the general public, thereby obtaining a listing on a stock exchange. It can be in the form of equity securities or debt securities. Through this process, the companies become an entity that can be publicly traded and owned. Companies decide to go public when they earn profits and capital returns and if the public demand for the company's share increases. This process is also known as Initial Public Offering or an IPO.

In the initial days of a business, it is aided by promoter funds that include the entrepreneur's savings. Afterwards, when it earns profit, angel investors fund the firm. Subsequently, when it grows further, the company is financed by Venture Capitalist firms and private equity firms. When the company wants to raise its capital further and extend its reach, it opts for IPO.

Why do companies launch an IPO?

A company launches IPO for various reasons. Here are some of the reasons why companies decide to go public:

Better Public Image

IPO lets a company gain more exposure and recognition. This, in turn, will allow customers to trust the company and the product and services they provide. It can lead to easy mergers and acquisitions alongside smoother cash flow due to its public listing of shares.

Raise Capital

One of the evident benefits of having an IPO is that it increases capital. The other methods of raising funds, such as applying for loans, are expensive and riskier. Banks offer a limited fund based on the analysis of the company applying for a loan. The interest rates are usually high when it comes to bank loans. On the other hand, IPO can help the company have a lump sum amount that can be used for various purposes like clearing off debts, research and development, expansion of business, etc. In other words, the more the funds, the better the possibility of growth of the business.

Price Transparency

Selling the equities will generate a lot of liquidity. It will make the company reach a stable financial condition, thereby increasing price transparency. This can also generate a liquid entity for shareholders who have been associated with the company for a long term.

Value Assessment

Once a company's stock gets listed in the exchange, its value is equal to that an investor is willing to pay for. Hence, it lets outsiders know the current value or worth of the company. Value assessment is indispensable for a company willing to grow in future and carry out mergers and acquisitions.

Enhanced Credibility

As a result of the launching of IPO and increased visibility, the company's credibility can also increase. The fiscal data can become more transparent and thereby fulfil SEBI's requirement by reporting to it periodically.

Also Read: Upcoming IPOs in 2021

Limitations

Every coin has two sides; similarly, every financial decision, over time, has boundaries as well. IPO is no exception. It has certain limitations also. Few of them have been stated in the following section:

  • Launching an IPO is not an easy process. It involves various stages like selecting investment bankers, roadshows, pricing of shares, SEBI's approval, and finally listing. It is a lengthy and critical procedure that needs supervision at every stage.
  • One needs to invest time and money for a successful IPO. There are upfront costs related to IPO, which are necessary. These include charges for underwriting, legal fees, accounting charges, registration charges, advertising costs, etc. Nevertheless, these are obligatory and help in carrying out the process correctly.
  • Unlike private companies, public companies must file their financial statements every year. It implies that the company should establish more rigorous financial controls, build a financial reporting team and audit committee. Thus, the reporting costs can go high because the company now has an answering liability to its investors.
  • Private companies have full control over themselves. However, IPO lets the entrepreneur share the control with the other investors and shareholders. He cannot enjoy autonomous power over the business anymore. He needs to involve others in the crucial decision-making processes of the company.

Key IPO Terms

To understand IPO and its benefits, we should be accustomed to some technical terms that are indispensable in this domain. The following are some of the most commonly used terms associated with IPO along with their definitions:

  • IPO: IPO stands for Initial Public Offering. It is the process by which a private company can go public by selling its shares to the public. By carrying out IPO, a company can get its shares listed on the stock exchange.
  • Venture Capital: Venture capital is the sum of money that a private equity investor provides to a company that shows high growth potential. The person who invests the amount is called a Venture Capitalist, and he finances this money in exchange for an equity stake.
  • Market Capitalization: Market Capitalization is the total market value of a company's total outstanding shares. It is calculated by multiplying the price of one unit of stock by its total number of shares owned by the public. It is an important figure that shows the relative size of a company.

Market Capitalization formula can be expressed as:

  • Market Capitalization = Current Market Share Price * Total No. of Shares Outstanding
  • Financial Windfall: A Financial Windfall is an unprecedented and unexpected profit or gains in a company. It can result from a sudden rise in demand for the company's stocks, surprise earnings, inheritance, settlement of claims, sale of property, etc.
  • Price Band: A Price Band is the lower and upper limit of the price of shares that is decided before a company goes public. It is the price range between which the company allots shares to the public. It is also called the offering range of shares.
  • Book Value: Book Value can be defined as a company's worth calculated according to the statement of its Balance Sheet. It is the net result of the aggregate book value of all the assets against the value of its intangible counterparts and liabilities. The formula of book value can be expressed as:

Book Value = Total Assets – Total Liabilities

  • Book Building: Book Building can be defined as a method of price discovery. It is a process by which an underwriter can determine the IPO price. It is a kind of bidding that involves generating, capturing and recording investor demand for shares.
  • Fresh Issue: It refers to a stock or bond offering that is made for the first time. They are issued primarily for raising funds or capitals for a company through Initial Public Offering.
  • Merchant Banker: A merchant banker acts as the connection between a company that wants to raise funds and investors willing to buy shares. He is responsible for underwriting corporate securities and advising companies whether to go for corporate mergers. His job profile also includes portfolio management, project counselling and insurance.

Importance of an IPO

IPO is a significant step in a company's development. It evidently enables the concern to raise capitals. Additionally, it plays an instrumental role in the firm's growth by increasing its credibility and exposure. The most significant function of an IPO is the inclusion of the public in the company's growth. Since price transparency is maintained in the process, the public can evaluate the company's worth, thereby checking the company's susceptibility to any downfall.

A company that is already listed on the stock may need additional capital for various purposes. Post IPO, if a company issues shares to the public, it is called FPO or Follow on Public Order.

 

Need for FPO

Follow on Public Offer or FPO is a process that begins after an IPO. Here, the company that has already listed its shares in the stock market goes to issue shares to more investors further. It is carried out to diversify the company's equity base. It is comparatively less risky than an IPO. The main objective of FPO is subsequent public investment.