IPO- Understand Inside Working

source- Newshour

An IPO (Initial Public Offering) is the process of transforming from a private company to a public listed company by way of selling shares. The main aim of a company going for an IPO is to raise funds from the public. Reaching the stage when a company can think of an IPO involves a whole lot of effort, let alone carrying out the process of IPO smoothly.

The company cannot just approach the stock exchange directly and list itself. The company first and foremost has to hire an investment bank. There can also be three to four investment banks working together on an IPO, with one bank taking the lead position. The company approaches the investment bank by explaining the business model of the company, the future vision and the risks involved. On the basis of the information provided to the bank, the bank gauges the market interest of the investors and if the bank predicts that the IPO would be successful i.e. investors will invest in the company, in spite of the business risks involved, the investment bank is on board.

Once the company has an investment bank on board, the company and the investment bank discuss how much money they can raise from the IPO, what kind of shares they have to issue, what would be the per share price and all other details in the underwriting agreement. The underwriting agreement is the agreement to be submitted to the SEC or SEBI (stock market regulator of a country) with all the details of the company and its IPO for registration. The agreement holds all the information that is there of the company from its birth. The stock market regulator then investigates the authenticity of the data, if everything is found genuine, the regulator decides a date for the IPO with the company.

After the approval from the stock market regulator, the investment bank prepares a prospectus (includes all the financial information about the company), which would be shown to the prospective investors to gather their interest.

Now comes the part of the road show. Road show is an around the world trip to present the prospectus to the prospective investors. If an investor shows interest in the IPO, he is offered shares at the IPO price (the IPO price is less than the price at what the company will get listed and start trading on the exchange). Now, as the road show approaches its end and the date of the IPO comes closer, the investment bank and the company decide on the share price at which the trading will begin.

They arrive at this price after taking into account the general market conditions, the success of the road show and any new developments. The higher this price, the more capital the company will raise from the market. Setting the optimum price is a difficult task. If the price set is too high, the investors won’t invest in the company and if the price set is too low, the company loses on the potential capital that it could have raised.

The IPO is a hit if the investors start buying the shares at the price the company is listed and as a result the share price starts increasing due to high demand.

Author | Akanksha Goel