An initial public offering (IPO) is a type of public offering where shares of stock in a company are sold to the general public, on a securities exchange, for the first time. Through this process, a private company transforms into a public company. Initial public offerings are used by companies to raise expansion capital, to possibly monetize the investments of early private investors, and to become publicly traded enterprises. A company selling shares is never required to repay the capital to its public investors. After the IPO, when shares trade freely in the open market, money passes between public investors. Reason for listing
When a company lists its securities on a public exchange, the money paid by investors for the newly-issued shares goes directly to the company. An IPO, therefore, allows a company to tap a wide pool of investors to provide it with capital for future growth, repayment of debt or working capital. A company selling common shares is never required to repay the capital to investors. Once a company is listed, it is able to issue additional common shares via a secondary offering, thereby again providing itself with capital for expansion without incurring any debt. This ability to quickly raise large amounts of capital from the market is a key reason many companies seek to go public.
IPO helps the company to create a public awareness about the company as these public offerings generate publicity by inducing their products to various investors.
•The increase in the capital: An IPO allows a company to raise funds for utilizing in various corporate operational purposes like acquisitions, mergers, working capital, research and development, expanding plant and equipment and marketing.
•Liquidity: The shares once traded have an assigned market value and can be resold. This is extremely helpful as the company provides the employees with stock incentive packages and the investors are provided with the option of trading their shares for a price.
•Valuation: The public trading of the shares determines a value for the company and sets a standard. This works in favor of the company as it is helpful in case the company is looking for acquisition or merger. It also provides the share holders of the company with the present value of the shares.
•Increased wealth: The founders of the companies have an affinity towards IPO as it can increase the wealth of the company, without dividing the authority as in case of partnership.
•IPO does not always lead to an improvement in the economic performance of the company. A continuing expenditure has to be incurred after the setting up of an IPO by the parent company. A lot of expenses have to be incurred in the form of legal fees, printing costs and accounting fees, which are connected to the registering of an IPO.
Procedure for issuing an IPO
When a company wants to go public, the first thing it does is hire an investment bank, which does the underwriting. Underwriting is the process of raising money by either debt or equity. Underwriters are middlemen between companies and the investing public. The biggest underwriters are Goldman Sachs, Merrill Lynch, Credit Suisse First Boston, Lehman Brothers and Morgan Stanley. The company and the investment bank will first meet to negotiate the deal. Items usually discussed include the amount of money a company will raise, the type of securities to be issued and all the details in the underwriting agreement. The deal can be structured in a variety of ways. For example, in a firm commitment, the underwriter guarantees that a certain amount will be raised by buying the entire offer and then reselling to the public. In a best efforts agreement, however, the underwriter sells securities for the company but doesn’t guarantee the amount raised. Also, investment banks are hesitant to shoulder all the risk of an offering.
Instead, they form a syndicate of underwriters. One underwriter leads the syndicate and the others sell a part of the issue. Once all sides agree to a deal, the investment bank puts together an offer document to be filed with the SEBI. This document contains information about the offering as well as company info such as financial statements, management background, any legal problems, where the money is to be used and insider holdings. The SEBI then requires a cooling off period, in which they investigate and make sure all material information has been disclosed. Once the SEBI approves the offering, a date is set when the stock will be offered to the public.