IPO is short for initial public offering. An IPO’s meaning is seen when a company offers its shares of stocks directly to the public. This is why a company’s IPO is also referred to as the company ‘going public.’ In short, via the initial public offering, the company is choosing to give up part of its ownership to stockholders. Before its IPO, a company is considered privately-owned.
Why does a Company go Public?
To raise capital for expansion and growth
Every company is in need of money for an increase in operations, as well as the creation of new products so it can pay off existing debts. To gain this much-needed capital for a company, it is vital that a company go public.
Allowing early investors and owners to sell their stake to make money
This is also often seen as an exit strategy for venture capitalists and initial investors. A company can become quite liquid through its sale of stocks in an IPO. A venture capitalist can sell their stock in a company at this time so they can reap the potential returns and take their exit from the company.
Greater public awareness
Initial public offerings are often star-marked in a stock market’s calendar. A lot of buzz and publicity goes around these events. They are a great way for a company to publicize its products and services to a fresh segment of customers in the market.
Purpose of IPO
For a company, its initial public offering is an exciting time. This means it has become successful enough to require a lot more capital so it can continue to grow. Oftentimes the IPO is the only way for the company to get enough cash so it can fund a massive expansion. The funds allow the company to invest in new infrastructure and capital equipment. An IPO can also help the company in paying off its debt.
Stock shares are often very useful for mergers and acquisitions. In case, the company is thinking of acquiring another business, it can offer its shares as a form of payment. If the IPO allows the company to attract the top talent, its because it can offer stock options. This will enable the company to pay its executives a fairly low wage upfront. In return, the initial public offering promises investors that they will be able to cash out through it at some point in the future.
For business owners, the IPO is a time where it is finally time to cash in on one’s hard work. Such individuals are normally senior management or private equity investors. These individuals typically award themselves a significant portion of the initial shares of the stock. They stand to earn millions the day that the company decides to go public. Many of these investors also earn the privilege of being listed on the Bombay Stock Exchange or the National Stock Exchange. Investors can refer to this as getting in on the ground floor. The reason for this is that IPO shares often skyrocket when they are initially made available on the stock market.
Drawbacks of IPO
The process of setting up an initial public offering for one’s company’s shares can be quite tedious. It can distract a company’s leaders from their business. Ultimately, this can hurt their profits. Foremostly, an investment bank needs to be hired. Investment firms are then tasked with the work of guiding the company as it goes through the ups and downs of the IPO process. It is therefore unsurprising that such firms charge a hefty IPO fee.
Secondly, business owners may not be able to take on the shares for themselves. In some cases, the original investors may require that they re-funnel all the money back into the company itself. Even if investors get the opportunity to take out their shares, they may not get the option to sell them for years. By selling their stock the investors could hurt the stock price of the company, especially if they begin to sell in large blocks. Investors would typically see this as a lack of confidence in the business. Thirdly, business owners ten to lose ownership control of the business as the Board of Directors now has the power to fire them.
Finally, a public company faces intense scrutiny from regulators such as SEBI- the Securities and Exchange Board of India. SEBI makes sure that all managers and investors partaking in an IPO strictly adhere to certain laws. Finally, during an IPO, many details about the business conducted by the company become public. This information might become a crutch to the company itself as competitors take note of their operations.
The function of IPO for Economy
The number of initial public offerings that are issued is typically a sign of the economy’s and the stock market’s health. During a financial recession, initial public offerings tend to drop as they are not worth the hassle, especially when share prices are depressed. When the number of IPOs grow, it is a sign that the economy is churning again and getting back on its feet.
The Bottom Line
An initial public offering is often considered a big event in the stock market for a reason. By choosing to invest in a good company, you stand the chance to earn decent returns in the longer run. The trick, however, is to identify the good performers from the rest. If you invest in an IPO of a company that has the potential to grow and expand, buying its shares can be advantageous to you. Think of it as similar to investing in a small-cap stock that suddenly blows up. A company with strong fundamentals can imply that it has a great chance of growing bigger. You have the opportunity to earn good returns over the long run.