The initial public offering, or the IPO, is a momentous event for most companies as well as investors. This is the moment when a privately owned company opens its doors to public investors. This gives the opportunity the public to purchase shares of a company that was always owned privately. Understanding an IPO and what it has to offer can be your ticket to exciting opportunities as an investor or a business owner.

Let's break it down for you: what is an IPO, how it works, and what are the benefits offered? Let's explore that in this blog.

What is an IPO?

An IPO, or initial public offering, is the process by which a private company first sells its shares to the general public. Thus, the firm raising capital can transfer ownership stakes to the public in the form of shares. Following the issuance of an IPO by a company, its shares become live for trading on stock exchanges in BSE and NSE.

Companies have, therefore, used the IPO mechanism as an important tool to tap into a more significant source of funding and to collect vast amounts of funds. This route offers an investment opportunity for investors that can put money into a company in its early stages of public trading; in most cases, there is a good prospect to make sizeable returns if the company does well.

How Does an IPO Work?

Here are the steps that companies must undergo before listing their shares on the exchanges. Here is how it works in a nutshell:

• Decision to Go Public

  
  A company will then determine that they are to go public. This is usually a decision based on the fact that a company requires more funds needed for growth, expansion, or to pay back debt. The leadership and the board of directors consider that an IPO is the best way to raise funds in order to raise the required capital.

• Selection of Underwriters

  
  Following that, the corporation decides which underwriters to engage with. An underwriter is normally an investment bank that helps the company sell the IPO and facilitate its planning. Underwriters are usually responsible for setting the price of the initial share that shall be sold during the IPO. They also market the IPO to potential investors.

• Valuation and Pricing

  
  Underwriting is the process through which underwriters can determine how much the company is worth and the shares that they will accept to sell and at what price. Again, this entails a perspective regarding the linkage between conditions in the market and the assets, liabilities, as well as prospects of the company. The amount of money then raised by the issue of share capital must be set against an interest in the raising of capital with the necessity of attracting investors.

• Filing the IPO Prospectus

  
  Then, the company files a detailed document called IPO prospectus with the regulatory authority of stock market i.e. SEBI. Prospectus will contain everything about the company's performance, model of business, risks, and how it is going to be using the money brought in from the IPO.

• Going Public

  
  At the time of the IPO, the stocks are opened for listing on the stock exchange. Therefore, from this point, public trading commences, and investors can later buy stocks based on that price. The company status changes from privately held to public.

Advantages of An IPO

There are several benefits for a company to be listed:

• Access to Capital

  
  Going public helps raise funds for companies. That is, an enormous amount of money is raised by selling shares to the public. The obtained capital can then be used for several activities such as expansion, research, acquiring other companies, and paying off earlier debts.

• Better Visibility and Status

  
  An IPO will increase the visibility of the company. A listing on a major exchange increases the reputation of the company and thereby raises its profile amongst investors, customers, and any future business partners. This may lead to increased branding, improved trust from stakeholders, and further opportunities for growth.

• Liquidity for Existing Investors

  
  An IPO provides liquidity to founders, early investors, and early employees. Shareholders may have been so locked in that it proved difficult to sell before the IPO. Once an IPO has been successfully executed, shares can be freely bought and sold on an open market, thus clearly outlining a clear path to liquidity for early stakeholders.

• Increased Credibility

  
  The company also enjoys regulation, financial reports, and all transparency associated with it, boosting credibility levels. The public companies, in addition, are more scrutinized, and this can help create an environment of trust around the company's products or services among customers, investors, or partners.

• Employees Motivation with ESOP (Employee Stock Ownership Plan)

  
  Companies can provide an equity incentive in the form of stock options; this is among the greater attractions to employees. Issuance of shares to the employees would enable the company in aligning the interests of the workforce with that of company’s long-term success. In most instances, employees holding the shares are placed directly into the process of gaining size and will hence have better morale and higher productivity.

• Stringent Market Valuation

  
  Publicly listed companies are better valued in the market. Investors pay a premium for the equity of publicly traded companies based on stability and growth prospects. This may also lead to better funding opportunities in the future.

An IPO, therefore is an important step for an expanding company because it provides access to capital, increases visibility, and goes along with many other benefits, but indeed, it represents an opportunity for investors to invest early in an organisation with good prospects. However, one should realise that IPO investment carries risks, and the prospects of any company along with the market conditions need to be carefully evaluated.

Therefore, it is highly important to know how to get a price for the IPO in order to make a well-informed decision whether you are a going-public company or an investor taking up this new opportunity. Knowing the procedure inside and outside the IPO helps companies and investors maximize their benefits from this powerful tool of finance.

Read our next blog to know more about upcoming IPOs of the year.