Earlier IPOs were offered only to the institutional and high net worth investor clients of the brokers. With the advent of online provision, retail and self-directed investors can also avail themselves of the opportunity. Therefore, understanding certain fundamentals about IPO is of absolute necessity. So, let's start.
What is an IPO?
Initial Public Offering is the distinction when a privately held company for the very first time goes public. Before IPO issuance, the company stays limited to its Founders, Angel Investors, Venture Capitalists, and very few others in terms of investment. With IPO initiation, the public becomes a part of the investment. Unlike regular shares, IPOs are directly issued from the company.
A Journey towards Initiating an IPO:
Why Do the Companies Conduct IPOs?
IPO floating attributes both strategic and financial advantages to the firm.
Strategic Advantages: When a firm goes for an IPO, it becomes a public company. There is visibility and reputation enhancement. The company gets a vital competitive edge over its unlisted competitors. The other strategic reason is to offer an exit to existing investors like venture capitalists or private equity funds. The company can allow old investors to exit, and new investors can help the company grow further.
Financial Advantages: Growing companies need capital for their internal operation and their business expansion in various formats. When the internal sources (which comes in the form of retained earnings and funds sourced from friends & family) get exhausted, the firms look for avenues through bank loans & private equity. When that too gets finished, the firms usually go for IPOs. The acquired fund is used to meet up the current and future requirements.
Investing in IPOs: Fundamentals to Know About
Reading the IPO prospectus is the place to begin.
Understand the business in terms of what the company is doing and its circle of competence.
Identifying the Market Opportunity. The size of the opportunity and the ability of the business to capture it, integrated with the market share, can make all the differences when it comes to the point of growth and shareholders' returns. However, market size only provides estimates.
Understand the Risks Involved. Stock market investment is always subject to a significant amount of market risks. Before investing, understand the nature & magnum of the risk elements involved. The current market environment, the number of competitors, and the quality of the product or service play a critical role in the risk assessment.
Take a Closer Look at the Company Management. Track any change (upcoming or already happened) because such changes impact the Company Performance significantly. Any kind of news piece about the change may create a powerful spark, which investors should & must consider.
Assess the Capital Structure (CS). When the firms take decisions between equity IPOs and debt IPOs, it is known as the Capital Structure (CS) Decision. CS explains what financial sources are used. It talks about the firm's financial position and the risk elements involved. Three ratios – such as debt to equity ratio, Net debt to equity ratio, and Interest coverage – are used to measure Capital Structure and differentiate amongst similar IPOs.
Glance through the Financials: Business financials are to be checked, both in terms of the historical growth of the business and how the company plans to utilize its available capital. Investors should take a careful note about the usage of funds specified in the IPO prospectus.
Check the valuation of the company. An overvalued IPO subscription may decline upon listing. Similarly, an undervalued subscription may cause a company's capital drainage. A comparison needs to be made for the fair valuation assessment on growth potential, company management, and competitive advantage amongst similar listed companies.
Certain other essentials: IPO floated by a reputed broker implies a robust due diligence check on a company's prospects. That gives an added comfort cushion to the investors in terms of mental security. However, the stock market investment is always subject to market risk. Therefore, the number of advisor or broker shares to be issued, the escrow period (i.e. the time needed for the new shares to get ready for the sale), the performance hurdles apply to these shares, etc., are to be checked.
Well, the selection is an essential criterion for IPO investment. For prudent decision making, investors should assess various factorials such as the number of shares to be sold, the price per share, percentage of shares to be sold, the underwriters, the financial accounts, the risk elements, and a timetable for investors to apply for shares. There are no full-proof rules for IPO stock selection as no one knows for sure how an IPO firm will perform in the aftermarket. As we have discussed, analyzing the IPO prospectus is very important. As far as the strategy is concerned, though they provide a strong foothold, the success by no way is guaranteed.
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