Equity finance: Initial Public Offering

This is the offering of company stocks or shares to the public and when done for the first time it is known as initial public offering or IPO. Commonly this method of expansion is used by smaller and younger companies looking for capital. It is also occasionally done by large established companies, which are privately owned, for public trading. The issuer of the IPOs take professional help to determine the type of security to issue, best price for the offering and right time to launch it in the market.

Investing in IPOs is very risky since the business that it does on the first day and after cannot be predicted. Mostly IPOs are issued by companies going through transitions in their growth and hence uncertainties increase regarding future value of the stock. Added to this is the non availability of historical data which is used for the analysis of the credibility of the company.

The main aim while having your company listed on a public exchange is to raise extra capital. It will do this with issuing additional new shares during the same time as the release of IPOs. The money of the IPOs is directly given to the company. Trades that are materialized later are exchanges between investors. Thus IPOs provide the company concerned with huge amounts of capital which can be utilized for future growth. The money does not have to be repaid but the investors have the right to profits made. In case of dissolution investors have the right to capital distribution.

Shareholders of the company who already exist have their holdings diluted in proportion to the company’s shares. Their share holdings would become more valuable and expressed in absolute terms as time and company progresses. The company which launches an IPO has the right to issue more shares which is again capital that can be used for expansion. These companies have a ‘rights issue’ which allows them this facility. The company raises money without debt in this way. This is the main attraction of public listing and is an incentive for companies who seek to be listed.

In the beginning, IPOs are generally under priced. This generates more interest in the particular stock. It is very profitable for the investors also since the offering price would be low but as soon as the market opens the price would increase, promising immediate profit for the investors. Under pricing however leads to notional loss of capital for the company that could have been raised had the stocks been sold at a higher price.

Over pricing might lead to lesser marketability of the IPOs and this could be trouble. If the stock price falls on the first day itself, the stock would struggle to come up. The marketability of the stock would be affected drastically and its value would be reduced. Thus the price of an IPO should be low enough to initiate interest and high enough to raise required amount of capital for the company. The investment bankers use many measures to finally determine the price of an IPO.