This article is written by Neethi Pillai, pursuing a Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from Lawsikho.com. Here she discusses “Advantages and Disadvantages of Investing in an IPO”.

Introduction

The Stock Market has interested people for over a century now. Stocks are seen by many as the fastest method to get rich. Be that as it may, there are in reality not many speculators who see the stock market and stocks in the correct point of view. To most, these are only tickers of costs going up and down. In the event that your ticker goes up, you profit. On the off chance that it goes down, you lose. That is both the beginning and the end of the story.

Yet, the insightful investor is more perceiving than that. He takes a gander at stocks as quotes going up and down, however as genuine, live businesses in real life. Go above and beyond and one understands that stocks can be one of the most remarkable asset classes to put invest in. They are a vehicle and mechanism that furnishes normal individual investors with some astounding advantages and openings that are unmatched by some other asset class.

Is Investing in Stocks a good way to Start Investing?

The stock market resembles a labyrinth. You need an outline to explore it effectively. Without a diagram close by, investors must depend on hearsay, as a rule, from other clueless investors. It’s an example of the blind leading the blind. Also, none of them even recognize they’re lost. 

This is the most noticeably terrible approach to invest in the stock market. There is another and a better way. 

One should initially locate an effective, attempted and-tried outline for stock contributing. Invest some energy in understanding this outline. At that point, and at exactly that point, dive in. 

You have to comprehend what to do. You have to realize how to do it. You have to realize when to do it. At exactly that point would you be able to hope to profit in the market, and keep it as well.

How IPO Comes into the Picture

An Initial Public Offer (IPO) alludes to the way toward offering shares of a private organization to general society in new stock issuance. Open offer issuance enables an organization to raise capital from public investors. The change from a private to a public company can be a significant time for private investors to completely acknowledge gains from their venture as it commonly incorporates share premiums for current private investors. In the interim, it likewise enables public investors to take part in the offering.

An organization arranging an IPO will normally choose one or more underwriters. They will likewise pick a Stock exchange where the shares will be issued and thereafter traded openly. 

The term Initial Public Offer (IPO) has been a trendy expression on Wall Street and among investors for a considerable length of time. The Dutch are credited with directing the first modern day IPO by offering shares of the Dutch East India Company to the overall public. From that point forward, IPOs have been utilized as a route for organizations to raise capital from public investors through the issuance of public share ownership. As the years progressed, IPOs have been known for upturns and downtrends in issuance. Individual sectors additionally experience upturns and downtrends in issuance because of development and innovation and other economic factors. Technological IPOs multiplied at the stature of the dot-com boom as new companies without revenues raced to list themselves on the stock market. The 2008 crisis brought about a year with minimal number of IPOs. After the recession following the 2008 crisis, IPOs came to a standstill, and for certain years after, new listings were uncommon. All the more as of late, a great part of the IPO buzz has moved to an emphasis on so-called unicorns—new businesses or startups that have arrived at private valuations of more than $1 billion. 

Investors and the media intensely speculate on these organizations and their choice to open up to the world by means of an IPO or remain private.

How IPOs Work

An IPO is a major step for a company. It gives the company access to raising a great deal of capital. This gives the company a more noteworthy capacity to develop and grow. The increased transparency and share listing credibility can likewise be a factor in helping it acquire better terms when seeking borrowed funds also. 

IPO shares of a company are valued through underwriting due diligence. At the point when a company opens up to the public, the previously owned private share ownership converts to public ownership and the current private shareholders’ shares become worth the public trading price. Share underwriting can likewise incorporate unique arrangements for private to public share ownership. By and large, the change from private to public is a key time for private investors to trade out and gain the profits they were anticipating. Private shareholders may hold their shares in the public market or sell a part of their shares for gains. 

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Meanwhile, the public market opens up a huge opportunity for many investors to purchase shares in the company and contribute capital to a company’s shareholders’ equity. The public comprises of any individual or institutional investor who is keen on investing in the company. In general, the number of shares the company sells and the cost for which shares sell are the creating factors for the company’s new shareholders’ equity value. Shareholders’ value still represents the shares owned by investors when it is both private and public, yet with an IPO the shareholders’ equity increments essentially with cash from the primary issue.

Underwriters and the IPO Process

An IPO completely comprises of two sections. The first is the pre-marketing period of the offering, while the second is simply the initial public offering. At the point when a company is keen on an IPO, it will publicize to underwriters by requesting private bids or it can likewise offer a public statement to produce intrigue. The underwriters lead the IPO procedure and are picked by the company. A company may pick one or a few underwriters to oversee various pieces of the IPO procedure cooperatively. The underwriters are associated with each part of the IPO due diligence, record keeping, documenting, marketing, and issuance.

Steps to an IPO

Stage 1: Preparation of Registration Statement 

To start an IPO procedure, the company involved must present a registration statement to the SEBI, which incorporates a detailed report of its fiscal wellbeing and business plans. SEBI investigates this report and does its very own background check of the company. It should likewise observe that registration statement satisfies all the mandatory requirements and fulfils all rules and regulations. 

Step 2: Getting the Prospectus Ready 

While awaiting the approval, the company, with help from the underwriters, must make a preliminary ‘Red Herring’ prospectus. It incorporates point by point financial records, future plans and the particulars of an expected share value range. This prospectus is intended for prospective investors who might be keen on purchasing the stock. It additionally has a legal warning about the IPO pending SEBI approval.

Step 3: Road-show 

When the prospectus is prepared, underwriters and company authorities go on countrywide ‘roadshows’, visiting the significant trade hubs and promote the company’s IPO among select few private purchasers (Usually Corporates or High Net Individuals). 

They are given detailed data in regards to the company’s future arrangements and development potential. They get a vibe of investor reaction through these visits and attempt to charm huge investors. 

Step 4: SEBI Approval 

Once SEBI is satisfied with the registration statement, it announces the statement to be effective, giving approval for the IPO to occur and a date to be fixed for the same. Sometimes it demands alterations to be made before giving permission. The prospectus cannot be given to the public without the corrections proposed by SEBI. The company needs to choose a stock exchange where it means to sell its shares and get listed.

Step 5: Deciding On Price Band and Share Number 

After the SEBI approval, the company, with help from the underwriters settles the price band of the shares and furthermore chooses the number of shares to be sold. 

Step 6: Availability to the Public

On the dates referenced in the prospectus, the shares become accessible to the public. Investors can round out the IPO frame and determine the cost at which they wish to make the purchase and present the application. 

Step 7: Issue-Price and Share Allotment 

When the subscription time frame lapses, individuals from the underwriting banks, share issuing company, etc. will meet and decide the cost at which shares are to be distributed to the prospective buyers. The price would be directly controlled by the demand and the bid price cited by investors. When the price is settled, shares are allotted to investors dependent on the bid amounts and the shares accessible. 

Step 8: Listing and Unblocking of assets 

The last step is the listing in the Stock Exchanges. Investors who have applied through ASBA and to whom shares were allotted would get the shares credited to their DEMAT accounts and their funds getting debited from their account. On the other hand, for those investors to whom the shares were not so apportioned, funds would get unblocked in their bank accounts.

Things a Prospective Investor needs to be aware of before investing in an IPO

Before you make the decision of investing in an IPO, the following are some steps that you could take:

• Conducting Research

• • Start by researching the company to develop an understanding of its business model, fundamentals and management team.

• • Read the prospectus, check out the growth and earnings potential of the company, and develop a case as to why it might succeed over the competition.

• • Does the company have strong earnings potential, or are they struggling to turn a quarterly profit? Could buying these shares increase your risk profile?

• • What are the implications of a market downturn on the value of these stock holdings?

• • Prior to buying shares, you should be able to confidently address:

• How this investment could help you meet your investment objective and how it fits into your overall strategy
• how the company makes money
• What are its key products or services
• Potential risks and rewards associated with investing in the company

• Understand the Risks

Once you complete your research, you may feel comfortable with your understanding of the company’s fundamentals, but it’s important to remember that investing in these securities can be risky for even the most well-informed investor.

Investing in new-to-the- market securities is like investing in any security – there are no guarantees. And there are several reasons why they may underperform, leaving an investor holding shares that trade below the initial share price.

But wait! We have not reached the advantages yet.

Firstly,

• Money to grow the business

With an infusion of cash derived from the sale of stock, the company may grow its business without having to borrow from traditional sources, and will thus avoid paying the interest required to service debt.

This “free” cash spent on growth initiatives can eventuate in a better bottom line. New capital may be spent on marketing and advertising, hiring more experienced personnel who require lucrative compensation packages, research and development of new products and or services, renovation of physical plant or new construction and dozens of other programs to expand the business and improve profitability.

• Money for shareholders and others

With more cash in the company coffers, additional compensation may be offered to investors, stakeholders, founders and owners, partners, senior management and employees enrolled in stock ownership plans.

Company stock and stock options may be used in an effective incentive program. In recruiting talented senior management personnel, stock and options are an attractive inducement. For employees, a performance-based program of stock and or option bonuses is an effective means of increasing productivity and managerial successes. Stocks and/or options may also be used in other forms of compensation, as well.

• Other benefits of going public too

Once the company has gone public, additional equities may be easily sold to raise capital.

A publicly traded company with a stock that has performed successfully will usually find it easier to borrow money, and at a more favorable rate, when additional capital is needed.

A publicly traded company may also have more leverage in negotiating with vendors, and be more attractive to customers. This is a critical aspect of business, and a company that keeps vendor costs low may post better profit margins. Customers usually have a better perception of companies with a presence on a major stock exchange, another advantage over privately held companies.

This is largely due to the regular audit and financial statement scrutiny that public companies have to undergo on a regular basis.

A publicly traded company conveys a positive image (if business goes well) and attracts high-quality personnel at all levels, including senior management. Such companies are growth-oriented, they answer to a board of directors and shareholders who continually demand increased profitability, and are quick to rectify management problems and replace poorly performing senior executives.

Some other Advantages

• Access to unlisted shares

Retail investors can get access to shares of good companies through investing in IPO. In the last few years, we have seen IPOs of some quality unlisted shares like Alkem, ICICI Lombard, Dr. Lal Pathlabs and so on.

• Access to quality shares of PSUs

Disinvestments of PSU companies have given opportunities to the retail investors to invest in quality shares of PSUs. One of the biggest outperformers of the last 15 years, Maruti was sold to the public by the Government through the IPO.

• Information Symmetry

Investors can get information about the company through their prospectus only. There is no other source of information. Therefore the institutional investors, insiders, and analysts do not have edge over retail investors in the terms of information availability.

• ASBA

This is a unique advantage of investing in IPO over the routine stock purchase. ASBA makes sure that the amount is credited only when the shares are allotted to the investors.

Conclusion

This article highlights the entire procedure of an IPO and jots down some of its major advantages and drawbacks. A prospective investor may, however, be the judge of his own conscience and make informed decisions based upon their own experience and knowledge of how the market operates. The saying does, in fact, go “Buyer, beware!”

Students of Lawsikho courses regularly produce writing assignments and work on practical exercises as a part of their coursework and develop themselves in real-life practical skill.