What is an IPO? :: What, How and Why of an IPO

by Amandeep Singh

in IPO

With the market conditions being worse during the last couple of months, we did not see any company coming out with an Initial Public Offer (IPO).

But now that the things are getting back to normal, we keep on listening to the IPO talk all around us with the companies again coming in to collect money from the Public.

We all keep listening about this term all the time. But after all, What is an IPO?
This article will answer all your questions about IPOs. So, just read on…

An Initial Public Offering (IPO) is essentially the birth of a company in its public form. It changes many things about the way that management runs the firm. IPOs are more common during the bull markets like the one that seems to be ongoing with the market about doubled in a period of 2-3 months.

In cases when a private firm is in need of capital for requirements that exceed its ability to self-finance, there are a few other ways the management and the firm’s ownership can utilize to provide this needed capital. These entities include debt, private investment or a public investment through an IPO. Each of these alternatives is evaluated based on the current and projected needs of the company in cash.

In an Initial Public Offering, a company’s owners sell a portion of the firm to the public investors. The company negotiates a sale of its stock to one or more investment banks that act as an underwriter for the offering. The small number of underwriters further sell their stock to the much larger number of investors in the public markets.

The Underwriters are in turn, compensated through the fees and underpricing in the stock that is being sold to them by the firm. The Underwriters are in a way taking a risk that they will be able to sell the stock they bought from the firm for more than that they paid to the firm.

The underwriter provides value to the firm by making large purchase and organizing an orderly sale of their initial stock.

Other institutional and retail investors can purchase the stock from the public market but it is totally not strange for an IPO to lead to a large and fast runup in the stock’s price in case there is a demand more than the supply. On the contrary, selling pressure can push prices back down and a lot of volatility is very common as was seen for the Reliance Power IPO that was listed in the Indian Markets.

There is statistical evidence available to suggest that investing in new IPO’s can definitely outperform a generic stock index.

Historical performance and financial data is not as easily available for a company issuing a new IPO as it is for a company that has been already been available in the public for a long time. This increases the number of things that are not known about the firm and can make these investments very risky. However, there is some information available about the firm through the public filings made before the offering.

However, despite the risks, it is likely that IPOs will continue to attract the investors because they are usually issued when the companies are in a transitional phase. Companies in transitions are exciting and interesting to the investors. The prospects for a big win and the possibility of becoming another “IPO-millionaire” can be very attractive.

Usually for IPOs as the history depicts, the IPOs have registered listing profits for the investors on back of the high demand wihch leads to oversubscriptions. But I would definitely suggesy you to understand the risks before you take a chance.

Happy Investing… ๐Ÿ™‚

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{ 3 comments… read them below or add one }

mack August 16, 2009 at 10:18 pm

There are many companies with dream of making an IPO but there are some points which they have to consider before making such IPO's such as, they should win trust of the public, small technology companies fail to attract investor attention, donโ€™t make an IPO in anticipation of success. For more details refer ipo research

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credit data leads February 18, 2010 at 2:25 am

Wonderful stuff.. really very informative. I’ll grab the RSS feed and will stay tuned for more. Oh, and I threw you a StumbleUpon vote ๐Ÿ˜‰

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Amandeep Singh February 18, 2010 at 12:56 pm

Thanks a lot ๐Ÿ™‚

I really appreciate the StumbleUpon love… and the RSS subscription ๐Ÿ™‚

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