Question

What is the purpose of an initial public offering (IPO)? How does an investment bank facilitate the process? List and describe several recent IPOs. Discuss the advantages and disadvantages of an IPO.

Please do not copy and paste.

Answer 1

An IPO is the process by which a private company issues its first shares of stock for public sale. This is also known as "going public."

Companies do not begin an IPO upon launch. While successful startups may go public eventually, it takes a firm time to establish the necessary business plan and market position. This is, in part, so that the firm can attract investors and in part so that it can meet many of the SEC's qualifications for an IPO.

Prior to launching an IPO a company may be held entirely by its founders or by a combination of firm principals and private shareholders. At this point the firm entirely controls its ownership structure. If it has shares, the firm's principals can restrict those shares to purchasers or investors of their choosing.

What Is an IPO?

An initial public offering (IPO) refers to the process of offering shares of a private corporation to the public in a new stock issuance. Public share issuance allows a company to raise capital from public investors. The transition from a private to a public company can be an important time for private investors to fully realize gains from their investment as it typically includes share premiums for current private investors. Meanwhile, it also allows public investors to participate in the offering.

A company planning an IPO will typically select an underwriter or underwriters. They will also choose an exchange in which the shares will be issued and subsequently traded publicly.

The term initial public offering (IPO) has been a buzzword on Wall Street and among investors for decades. The Dutch are credited with conducting the first modern IPO by offering shares of the Dutch East India Company to the general public. Since then, IPOs have been used as a way for companies to raise capital from public investors through the issuance of public share ownership. Through the years, IPOs have been known for uptrends and downtrends in issuance. Individual sectors also experience uptrends and downtrends in issuance due to innovation and various other economic factors. Tech IPOs multiplied at the height of the dot-com boom as startups without revenues rushed to list themselves on the stock market. The 2008 financial crisis resulted in a year with the least number of IPOs. After the recession following the 2008 financial crisis, IPOs ground to a halt, and for some years after, new listings were rare. More recently, much of the IPO buzz has moved to a focus on so-called unicorns—startup companies that have reached private valuations of more than $1 billion.

Investors and the media heavily speculate on these companies and their decision to go public via an IPO or stay private.

Volume 75%

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Initial Public Offering (IPO) Explained

How IPOs Work

Prior to an IPO, a company is considered private. As a private company, the business has grown with a relatively small number of shareholders including early investors like the founders, family, and friends along with professional investors such as venture capitalists or angel investors.

When a company reaches a stage in its growth process where it believes it is mature enough for the rigors of SEC regulations along with the benefits and responsibilities to public shareholders, it will begin to advertise its interest in going public. Typically, this stage of growth will occur when a company has reached a private valuation of approximately $1 billion, also known as unicorn status. However, private companies at various valuations with strong fundamentals and proven profitability potential can also qualify for an IPO, depending on the market competition and their ability to meet listing requirements.

An IPO is a big step for a company. It provides the company with access to raising a lot of money. This gives the company a greater ability to grow and expand. The increased transparency and share listing credibility can also be a factor in helping it obtain better terms when seeking borrowed funds as well.

IPO shares of a company are priced through underwriting due diligence. When a company goes public, the previously owned private share ownership converts to public ownership and the existing private shareholders’ shares become worth the public trading price. Share underwriting can also include special provisions for private to public share ownership. Generally, the transition from private to public is a key time for private investors to cash in and earn the returns they were expecting. Private shareholders may hold onto their shares in the public market or sell a portion or all of them for gains.

Meanwhile, the public market opens up a huge opportunity for millions of investors to buy shares in the company and contribute capital to a company’s shareholders' equity. The public consists of any individual or institutional investor who is interested in investing in the company. Overall, the number of shares the company sells and the price for which shares sell are the generating factors for the company’s new shareholders' equity value. Shareholders' equity still represents shares owned by investors when it is both private and public, but with an IPO the shareholders' equity increases significantly with cash from the primary issuance.

The main recent IPO

1.UJJIVAN FINANCE LTD

2.NMDC LTD

3. FOOD WORKS LTD

these are all the main recent IPO'S

The following is the main advantage and disadvantage of IPO

Advantages

Fundraising

The most often cited advantage of an initial public offering is money. In 2016, the median proceeds received from an initial public offering were $94.5 million, and many offerings bring in hundreds of millions of dollars. For example, in 2016, the largest IPO—ZTO Express—netted $1.4 billion. The proceeds from an IPO provide ample justification for many companies to go public even without looking at the other benefits, especially considering the many investment opportunities available because of the new capital. These funds can benefit a growing company in countless ways. Companies may use an initial public offering to finance research and development, hire new employees, build buildings, reduce debt, fund capital expenditure, acquire new technology or other companies, or to bankroll any number of other possibilities. The money provided by an IPO is significant, and can transform the growth trajectory of a company.

Exit Opportunity

Every company has stakeholders who have contributed significant amounts of time, money, and resources with the hopes of creating a successful company. These founders and investors often go for years without seeing any significant financial return on their contributions. An initial public offering is a significant exit opportunity for stakeholders, whereby they can potentially receive massive amounts of money, or, at the very least, liquefy the capital they currently have tied up in the company. As stated in the previous paragraph, initial public offerings often raise nearly $100 million (or even more), which makes them very attractive to founders and investors who often feel that it is time to receive financial compensation for years of “sweat equity1.” It is, however, important to note that in order for founders and investors to receive liquidity from an IPO, they will have to sell their shares of the now-public company on a secondary exchange2(e.g., New York Stock Exchange). Shareholders do not immediately receive liquidity from the proceeds of an IPO.

Publicity And Credibility

If a company hopes to continue to grow, it will need increased exposure to potential customers who know about and trust its products; an IPO can provide this exposure as it thrusts a company into the public spotlight. Analysts around the world report on every initial public offering in order to help their clients know whether to invest, and many news agencies bring attention to different companies that are going public. Not only do companies receive a great deal of attention when they decide to go public, but they also receive credibility. To complete an offering, a company must go through intense scrutiny to ensure what they are reporting about themselves is correct. This scrutiny, combined with many individuals’ tendencies to trust public companies more, can lead to increased credibility for a company and its products.

Reduced Overall Cost Of Capital

A major obstacle for any company, but especially younger private companies, is their cost of capital. Before an IPO, companies often have to pay higher interest rates to receive loans from banks or give up ownership to receive funds from investors. An IPO can lessen the difficulty of receiving additional capital significantly. Before a company can even begin its formal IPO preparation process, it must be audited according to PCAOB3 standards; this audit is normally more scrutinizing than any prior audits, and fosters greater confidence that what a company is reporting is accurate. This increased assurance will likely result in lower interest rates on loans received from banks, as the company is perceived as being less risky. On top of lower interest rates, once a company is public, it can raise additional capital through subsequent offerings on the stock exchange, which is usually easier than raising capital through a private funding round.

Stock As A Means Of Payment

Being a public company also allows for the use of publicly traded stock as a means of payment. While a private company has the ability to use its stock as a form of payment, private stock is only valuable if a favorable exit4opportunity arises. Public stock, on the other hand, is essentially a form of currency that can be bought and sold at a market price at any moment, which can be helpful when compensating employees and acquiring other businesses. For a company to thrive, it must hire the right employees. The ability to pay employees with stock or offer stock options allows a company to be competitive when trying to hire top-tier talent, even if the base monetary salary is lower than what competitors are offering. Additionally, acquisitions are often an important way for companies to continue to grow and stay relevant. However, acquiring other companies is normally very expensive. When a company is public, it has the option to issue shares of its stock as a means of payment, rather than using millions of dollars of cash.

Disadvantages

Additional Regulatory Requirements And Disclosures

Unlike private companies, public companies are required to file their financial statements with the Securities and Exchange Commission (SEC) every year. These financial statements must be prepared in accordance with United States Generally Accepted Accounting Principles and audited by a certified public accounting firm. These SEC regulations are both burdensome and costly. Reporting a company’s financial position publicly requires that company to establish more stringent financial controls, staff a financial reporting team and audit committee, implement quarterly and yearly financial close processes, hire an audit firm, and complete hundreds of other tasks. These responsibilities cost public companies millions of dollars every year and require thousands of labor hours. For more information about public company audits see our article Audit prep for the Big Leagues.

Market Pressures

Market pressures can be very difficult for company leadership who are used to doing what they feel is best for the company. Founders tend to have a long-term view, with a vision of what their company will look like years from the present and how it will impact the world. The stock market, on the other hand, has a very short-term, profit-driven view. Once a company is public, its every move is scrutinized by investors and analysts around the world, who are generally interested in one question: “Will this company meet its quarterly earnings target?” If a company meets its target, its stock price will normally increase; if not, its stock price will normally decrease. Even if leadership is doing what is best for the company in the long-run, failing to meet the public’s short-term goals may cause the company to lose value and the leadership might be replaced as a result. Founders who do not like the idea of being constrained by short-term public goals should think carefully about going public.

Potential Loss Of Control

One major disadvantage of an IPO is founders may lose control of their company. While there are ways to ensure founders retain the majority of the decision-making power in the company, once a company is public, the leadership needs to keep the public happy, even if other shareholders do not have voting power. Going public means receiving considerable amounts of money from public shareholders. Since shareholders have given the company so much money, they expect the company to act in their best interest, even if it means going in a direction the founders dislike. If shareholders feel the company is not operating in a way that will help them make money, they will force the company, through shareholder votes or public criticism, to appoint new leadership.

Transaction Costs

Initial public offerings are expensive. Beyond the recurring expenses of public company regulatory compliance, the IPO transaction process comes at a hefty cost. The largest cost of a public offering is underwriter5fees. Underwriters will typically charge between 5% and 7% of the gross proceeds, which means the underwriter’s discount can cost up to $7 million on an average IPO. On top of underwriter fees, companies who raise an average amount of proceeds (approx. $100 million) should expect to spend about $1.5 – 2 million in legal fees, $1 million on auditor fees, and $500,000 on registration and printing fees. The transaction costs will be even higher if a company chooses to hire a financial reporting advisor6, or other specialty groups. See our article on the costs of going public for more information.

Conclusion

An initial public offering may or may not be the right direction for your company. IPOs come with a host of advantages and disadvantages. While this article highlights many of the common pros and cons of an IPO, it is not comprehensive. If you are considering an IPO, be careful to weigh all of the advantages and disadvantages, be patient, and consider all of your alternatives. For more information on these alternatives, read our Alternatives to an IPO article......