IPO - Initial Public Offering

For a company to grow, it will need funds. After a certain point, the owners or promoters will find it challenging to find funds for expansion and growth from their resources. So they look for other sources of funding. They have two options – they can either borrow from banks or go public and come out with an initial public offering (IPO). Borrowing from banks is a less desirable option because they have to pay interest, and will have substantial debt on their books. For investors, IPOs are an opportunity to cash in on a new company’s growth story. However, to invest in these, you would need an IPO account.

What is an IPO?

As we mentioned above, when a company needs funds to grow, it approaches the public for funds. It offers shares in the company to the investing public in exchange for cash. In short, the management relinquishes some part of the ownerships to investors, who become part-owners of the company.

IPO shares are reserved for specific categories of investors like high net-worth individuals and qualified institutional buyers. After allotment, the investors are free to sell the shares and make any profit if there is price appreciation.

IPOs are not just for equity alone. Companies can issue IPOs for non-convertible debentures and bonds as well. These are other ways in which companies can raise money from the public without relinquishing any control of the ownership.’

From the pricing perspective, IPOs can be divided into two – fixed price issue and book built issue. In a fixed price issue, the company that is coming out with an IPO sets the IPOO price beforehand, and this is mentioned in the prospectus. In a book-built issue, no price is fixed previously. Instead, it is decided upon according to investors’ demand. Investors have to bid within a price band, and the difference between the floor and ceiling of the band should not be more than 20 percent.

Advantages of IPOs

When you open an account for IPOs, you expect some benefits.

Early investor advantage: From the long-run perspective, you could be making in an investment in a company that could grow into a behemoth over time — especially a company that came up with an innovative new product or service. An investment of USD 1,000 in Microsoft in 1986 would be worth over one-and-a-half million dollars today! Of course, not every company is a Microsoft, and it’s hard to predict the future fortunes of any company. But it could be a gamble worth taking.
Make immediate gains: Sometimes, the price of the IPO increases as soon as the share is listed on the exchange. So there could be an opportunity to make quick gains. You must remember that companies usually sell the IPO for a little under what their real value is so that it attracts investor interest, and the IPO is fully subscribed. Once the company is listed, the price may skyrocket and may put its shares out of your reach if you do want to buy them.
Preferential treatment for small investors: Under SEBI guidelines, small investors get preferential treatment in the allotment of shares and also get a discount on the price. So this presents an opportunity for small investors to cash in.
Price transparency: IPO prices are more transparent than shares in the secondary market, that is, shares listed on the stock exchange. You know precisely what the costs are how they are arrived at, and they are the same for all investors.
Encouraging entrepreneurship: Entrepreneurship is the foundation of capitalism. Without it, an economy cannot grow and prosper. To grow, entrepreneurs need funds, and IPOs are the best way of going about getting some. Without IPOs, new companies may find it difficult to expand.

How to invest in IPOs

Once you’ve opened an IPO account, you need to find which one is the best. Lots of companies come up with IPOs, but not all of them are the same. So you need some criteria to find one that is suited to your needs. Here are some:

Getting information: Since these companies are privately held, public information on them can be scarce, unlike listed shares. So you may have to take a little more effort to look for information on the Internet and through other sources. Some of the things you should look at are the market, management and money. Is there a market for the product/ service, what’s the track record/ qualification of the management, and the money position – whether the company has a lot of debt.
USP: What’s the unique selling proposition of the company? Does it have an innovative new product or service to offer? Does it have any competitors?
Read the prospectus: It can be hard to read pages and pages of seemingly incomprehensive information in small print. But you are parting with your hard-earned money here, so it’s better to go through it if you don’t want to lose money. Don’t get carried away by the hype.
Underwriters: It’s also a good idea to look at the underwriters of the public issue. Reputed underwriters tend to do a lot more due diligence, so the risk of getting conned by fly-by-night operators is considerably reduced.
Proceed with caution: Equity investing involves market risk, and it could be higher in the case of IPOs. So it’s better to proceed with caution. Invest only in businesses that you’re familiar with. If you don’t, take the help of an investment adviser.