IPO| Advantages and Disadvantages

Investing in IPO has always been an attractive offer from the companies. A corporate decides to raise capital in the primary market by way of initial public offer, rights issues or offer for sale or equities or debt. Let us understand what exactly is an IPO and how important is the process of IPO in securities market

So what exactly is an IPO?

An IPO means Initial Public Offering. When the company first sells its shares of stock to the public it means Initial Public Offering. It simply means transferring the ownership from private to public. IPO is generally referred to as “going public”.

Why Companies decides to Offer IPO?

Companies decides to offer IPO because through IPO the funds raised are used to pay off debts, growth and expansion are executed.  In this process the company appoints an underwriter to help with the securities registration process and distribution of the shares to the public.  The underwriter appoints investment banks and brokers usually known as syndicate who will be responsible for selling shares as IPO.

Why One Decides to Invest in IPO?

Through IPO, investors will become shareholders of the company. A Shareholder receives dividend, bonus shares based on the company’s earning. IPO are equity investments and therefore they can provide good returns. Investors believe that the shares offered through IPO are low and if company performs better in future, the share prices can go up.

Below mentioned reasons states why one should invest in IPO

1. Discounts offered
2. Wealth Generation due to equities.
3. Most of Companies who offer IPO are quality companies

What are the Benefits of Investing in IPO?

There are many benefits of Investing in IPO. Companies get their stock valued and mention the offer price in the prospectus. An investor can apply for a particular number of shares. If the listing price is more than is more than what is listed on the IPO then it is called listing gain.

Let us understand benefits of Investing in IPO in detail

1. Listing Gains

The first benefit of investing in IPO is Listing Gains Which means the day when the IPO gets listed if the   share price is more than what was invested then it is known as Listing Gain.

2. Liquidity

Investors can sell the stocks in the open market once the company goes public.  Because of this there is liquidity as the investors can buy and sell the shares whenever they want.

3. Small Retailers can earn

SEBI has made several rules and regulations to ensure that small retail investors get a chance to invest in IPO. Sometimes small investors do not get fair chance in the secondary market.

4. IPO Norms

The third benefit by investing in IPO is IPO markets are safe and professional. The company prospectus gets all information like performance, financials, growth risk and future plans Here investors gets enough information to decide which investments are best.

5. Transparency

Investors who invest in IPO and receives shares through the allotment becomes the shareholder  The company owner ensures that investors are retained with them  Also the company plans to achieve its goals and reach profit levels as promised to the investors and analysts. The stock price will rise or fall depending on the company’s performance.

6. Economical

SEBI has developed an application that supports the blocked amount of an IPO. This application ensures that the money is debited from the account only after the shares are allotted. The money continues to receive interest till the time of allotment.  However it is not the case with the secondary market where the money is immediately debited from the account.

7. Shareholder Ownership Authority

When you invest in the company you receive the voting rights in the company. For example company decides in its annual general meeting that it will open new branches and planning for expansion. Shareholders have the right to vote against or for the decision.

8. Buying Cheap

The IPO is offered often at the lowest price. This is because the company offers shares at a discounted rate. This is why IPO becomes beneficial as it may be difficult to buy shares when the price increases.

Disadvantages of an IPO

1. Transaction Cost

Initial Public Offering cost lot of money. One such high cost involved is payment to underwriters. Apart from this there are costs involved like legal fees, Accounting Fees, Listing Fees.  Companies who are going public work with the law firm to carry out the legal due diligence.

2. Time Consuming

Although the pricing and success details of the company are mentioned in the prospectus, an investigation of the company requires time and effort.

3. Risk of Selling Shares

Many investors nowadays want to sell their shares soon after the listing if there is profit. But it’s sometimes only to do the same. Selling is quite simple but there are chances that there will be no potential buyers in the market.

4. Loss of Control

A company’s founders may have less influence over its organization after an initial public offering. When a company becomes public customer satisfaction becomes very important. Votes from shareholders and negative public perception might compel a change in leadership.

Planning Required Before Going for IPO

When the company decides to go for IPO, it must first build the right team to go public.  The company must select competent lead managers and merchant bankers for issuing IPO.  Internal Restructuring of the company is very important aspect.  Easier compliance management, existing capital restructure and better presentation and transparency in the financial statements is very important. 

Secondly the company should do proper SWOT analysis. Company should review its Strategic Objectives, Business Threats, and Market Size for its products and services. There are two major reasons for going public. One is to raise funds through capital markets and second is for growth and building up resources. A company should check whether it has clear and valid strategies. 

A company should have good business predictability and a 10 year long vision towards developing its own company. So company management should check whether the company business model is predictable.

Risk Analysis of Threats from Market Forces

Company should make Risk Analysis and Appropriate Risk Mitigation strategies to ensure minimal impact from any Business threats. Business risk on the operational and financial front, there is risk around compliance like regulatory risk, legal risk and code of conduct risk, risk around compliance like regulatory risk, legal risk, and code of conduct risk, risk around communication and investor relationship and climate and reputational risk. 

The management must consider transferring the financial impact of this risk and its future ramifications onto risk transfer mechanisms such as IPO insurance to safeguard their people, profits and public image.

Underwriting Fee

Underwriting Fee are the largest single direct cost associated with an IPO. A fixed fee is distributed among all bankers handling the IPO mandate.  Then there are variable fees which could vary from transaction and transaction and is dependent on parameters such as the procurement done by banks on the institutional and retail HNI side. 

Legal Fees

Companies working with external counsel and underwriter counsel incur cost for due diligence on the company’s operations, management and business. Drafting of the Forms and providing other advice related to the offering, interactions with the underwriter their counsel and other matters related to going public.

Accounting

Companies incur accounting costs in working with the auditor and accounting advisor. Such costs directly contribute to the IPO costs. It includes technical accounting and financial reporting issues, interactions with underwriter counsel and external company counsel on matters directly related to the offering.

Conclusion

An Initial Public Offering has both advantages and disadvantages.  If an investor is considering to invest in IPO he must first carefully analyse and be patient. Before investing in IPO one should remember that no investment is free of risk. Investing IPO does not mean that always it will be profitable. At the same time one should understand one own risk appetite. One must access financial situation age liabilities and other factors before investing in IPO.

Then the next important point is investor must understand and do a research the reason for which the company is raising money.  Every investment banks publishes a prospectus for the IPO. So it is very important to read the prospectus very carefully.

Apart from Prospectus the investor should look for reports and analysis done by third parties in magazines, newspapers and journals. Investor also should if there is any lock up period for investing in IPO. Lastly investor should never get over excited for any investments as investment market is subject to market risk.