Full Form Of Ipo Initial Public Offering How It Works

Full Form of IPO – Initial Public Offering

The Full Form of IPO is Initial Public Offering. The term “Initial Public Offering” refers to when a firm offers its shares to the public for the first time. For going public, the company must list it’s shares on a stock exchange, as investors can only purchase shares listed on a stock exchange.

How Does IPO Work?

Let’s discuss the process of Initial Public Offering.

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#1 – Selection of Investment Bank

It is the first step of any IPO to choose a bank that will guide & advise them on their IPO and provide an underwriting service. The underwriterUnderwriterThe underwriters take the financial risk of their client in return of a financial fee. Market Makers like financial institution and large banks ensure that there is enough amount of liquidity in the market by ensuring that enough trading volume is there.read more works as a broker between company and investor and helps the issuing company sell its share in the initial stage.

#2 – Types of Underwriters

A – Firm Commitment

In this arrangement, the underwriter guarantees the company that the agreed sum of money will be raised if there is any shortfall in raising funds through public investors. The underwriter will buy the remaining shares and fulfill his commitment.

B – Best Effort Commitment

In this arrangement, the underwriter does not guarantee to the issuing company; instead, the underwriter only helps sell the company’s securities.

C – Syndicate of Underwriters

In this arrangement, more than one investment bankInvestment BankInvestment banking is a specialized banking stream that facilitates the business entities, government and other organizations in generating capital through debts and equity, reorganization, mergers and acquisition, etc.read more is involved in selling the company’s shares. Out of these banks, one will lead and form a syndicate, as well as form a mutually beneficial alliance with others.

#3 – Engagement Letter

After selecting the investment bank, an engagement letter will be prepared by both the party in which all the terms and conditions are mentioned like all the out of pocket expenses incurred by the underwriter will be reimbursed by the issuing company, underwriter discount, which is the difference between the sale price of the share to the public and purchase price of the underwriter from the company.

#4 – Letter of Intent

Letter of intentLetter Of IntentA letter of intent, also known as LOI, is a preliminary contract containing key terms of a prospective business deal between two or more parties. It is common in business transactions, for example, the sale, purchase, merger, or formation of a joint venture. read more includes the underwriter’s commitment as per the arrangement to the issuing company and dedication given by the company to an underwriter that the company will provide all the relevant information relating to this IPO.

#5 – Underwriting Agreement

After complete, all the above things underwriting agreement will be executed between the company and underwriter by which both the party will be contractually bound.

#6 – Registration Statement

The issuing company and underwriter will prepare a registration statement in which company history will be mentioned, like a financial statementFinancial StatementFinancial statements are written reports prepared by a company’s management to present the company’s financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.read more of an earlier period, management details, promoters holding, legal issues, and any other information which may influence the investors. This registration statement needs to file to SEC (US Security and Exchange Commission)

#7 – Red Herring Prospectus

It is the company’s first prospectus prepared by the underwriter and includes all the company information. This document is ready for investors who are willing to buy stocks.

#8 – Pricing Decision

After getting approval from the SEC company, an underwriter will decide the price of a share and the lot size offered to the public.

#9 – Opening of IPO

After finalizing the price, the company opens the IPO for the public, and generally, it will run 4 – 5 days.

#10 – Allotment of Shares

Allotment of shares will be allotted to the investor as per their bidding. It may be fully subscribed/undersubscribed/oversubscribed. In case of oversubscribing, claims will be allocated to the investor on a pro-rata basis.

Eligibility Criteria to Apply for an IPO

The company must have 400 or more shareholders holding 100 or more shares.There should be 1.10 million publicly traded stocks.At the time of listing, the share price should be at least $4 per share.The market value of shares should be at least 40 million.Aggregate profit before taxProfit Before TaxProfit before tax (PBT) is a line item in a company’s income statement that measures profits earned after accounting for operating expenses like COGS, SG&A, depreciation & amortization, and non-operating expenses. It gives the overall profitability and performance of the company before making payments in corporate taxes.read more earnings of the last three should be $ 10 million, out of which the previous two years pre-tax earnings should not be less than $ 2 million, and there should not be lost in any of the last three years.Market capitalizationMarket CapitalizationMarket capitalization is the market value of a company’s outstanding shares. It is computed as the product of the total number of outstanding shares and the price of each share.read more must be at least $ 550 million.The previous year’s revenue must be at least $ 100 million.

Why Does a Company Offer IPO?

It helps raise the fund because a large number of the public will invest in the company by buying shares.It increases its reputation, brand reputation, and market opportunity because more people will know about it.It helps in getting the loan with lesser interest costs.It increases the liquidityLiquidityLiquidity is the ease of converting assets or securities into cash.read more because any time shareholders can sell their shares, management/promoters can also quickly sell their shares.It attracts employees also, and they will also get motivated.

Things to Remember Before Investing in IPO

The Company’s past performance and when the company has been established.How much stocks are going to the public, and how much they will keep with themselves.Who will be the managing director and top management of the company, and how much is the experience to them.What is the vision & mission of the company from the red herring prospectusRed Herring ProspectusThe term “Red Herring prospectus” refers to the preliminary prospectus that a company files with the SEC in relation with its initial public offering. It contains information about the company’s operations but does not include details about the prices at which securities are issued or their numbers.read more? How will the company increase its profitabilityProfitabilityProfitability refers to a company’s ability to generate revenue and maximize profit above its expenditure and operational costs. It is measured using specific ratios such as gross profit margin, EBITDA, and net profit margin. It aids investors in analyzing the company’s performance.read more and share price of the company?What are the company product and consumption capacity of that product?What is the market share of the company?

Example of IPO

Let’s take an example.

Conclusion

Companies are going for Initial Public Offering to raise funds from the public. It provides various benefits to the company, like increasing the company’s valuation, increasing their market shares, liquidity, and product awareness among the people. However, at the same there are some disadvantages of IPO also like owners/promoter does not have complete control over the company because after a board of directorsBoard Of DirectorsBoard of Directors (BOD) refers to a corporate body comprising a group of elected people who represent the interest of a company’s stockholders. The board forms the top layer of the hierarchy and focuses on ensuring that the company efficiently achieves its goals. read more and shareholdersShareholdersA shareholder is an individual or an institution that owns one or more shares of stock in a public or a private corporation and, therefore, are the legal owners of the company. The ownership percentage depends on the number of shares they hold against the company’s total shares.read more will manage the listing company is the owner of the company, and they can choose the directors who will run the company.