An IPO or Initial Public Offering is where for the first time an earlier unlisted company sells new or existing securities and offers them to the public in the primary market.
A company before an IPO is considered to be private with a small number of shareholders, whereas after an IPO the issuing company is recognized as a publicly listed company as it reaches its growth stage where it can obtain a huge amount of capital.
This provides the company to increase the profit potential and a key time for private investors to cash in and earn their expected returns. The public market opens up a massive opportunity for investors to buy shares in the company and contribute capital to a company’s shareholders' equity.
Let's have a look at the IPO process of a company going public for the first time i.e. Initial Public Offering steps explained in easy manner.
The first step in the IPO process is for the issuing company to choose an investment bank to direct the company on its IPO and to provide underwriting services. While selecting an investment bank the reputation, research quality, industry expertise, and prior relationship with the bank must be noted.
The process by which an investment bank acts as a middleman between the issuing company and the investor while helping the issuing company to sell the initial set of shares is called underwriting. There are many underwriting arrangements that are open to the issuing company including -
● Firm Commitment
● Best Efforts Agreement
● All or None Agreement
● Syndicate of Underwriters
There are a number of documents that an underwriter must draft such as,
● Engagement Letter
● Letter of Intent
● Underwriting Agreement
● Registration Statement
● Red Herring Document
After the approval by the SEC, an effective date is decided before which both the issuing company and the underwriter fix the price at which the shares will be sold by the issuing company. This price is at which the issuing company raises capital for itself.
An underpriced IPO is when the investor can expect a rise in the price of the shares on the offer day. It also increases the demand for the issue. An offer oversubscribed is considered to be a good IPO.
The underwriter provides the recommendation of an analyst to create a marker of the stock issued. The underwriter has the liberty to trade and change the price of the issue as prohibitions against price manipulation are suspended.
In the final stage of the IPO process, the market competition starts after 25 days of the IPO. After the period lapses, underwriters provide an estimate regarding the earning and valuation of the issuing company.
An IPO is primarily a fundraising method used by massive companies, in which the company sells its shares to the public for the first time. Some of the central reasons for undertaking an IPO include - raising capital from the sale of the shares, providing liquidity to company founders and early investors, and taking advantage of a higher valuation.