Full Form of IPO – Initial Public Offering
The Full Form of IPO is Initial Public Offering. The term “Initial Public Offering” refers to when a firm offers its shares to the public for the first time. The company must list them on a stock exchange, as investors can only purchase shares that are listed on a stock exchange. By listing shares on a stock exchange and issue an IPOIPOInitial Public Offering (IPO) is when the shares of the private companies are listed for the first time in the stock exchange for public trading and investment. This allows a private company to raise the capital for different purposes.read more, a private limited company can convert into a public limited company. Companies are issuing IPO for raising funds from the market, and in return, the investors will get the benefit of appreciation in shares price and dividend/bonus.
How Does it Work?
Let’s discuss the process of Initial Public Offering.
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Source: Full Form of IPO (wallstreetmojo.com)
#1 – Selection of Investment Bank
This is the first step of any IPO to choose a bank that will guide & advise them on their IPO and provides an underwriting service. The underwriterUnderwriterThe underwriters take the financial risk of their client in return of a financial fee. Market Makers like financial institution and large banks ensure that there is enough amount of liquidity in the market by ensuring that enough trading volume is there.read more works as a broker between company and investor and helps the issuing company to sell its share in the initial stage.
#2 – Types of Underwriters
A – Firm Commitment
In this arrangement, the underwriter gives a guarantee to the company that the agreed sum of money will be raised if there is any shortfall in raising funds through public investors, then the underwriter will buy the remaining no, of shares and fulfill his commitment.
B – Best Effort Commitment
In this arrange,ment underwriter does any guaran to the issuing company; rather, he will only help to sell company’s securitiespany.
C – Syndicate of Underwriters
In this arrangement, more than one investment bankInvestment BankInvestment banking is a specialized banking stream that facilitates the business entities, government and other organizations in generating capital through debts and equity, reorganization, mergers and acquisition, etc.read more is involved in selling the company’s shares, and out of these banks, one will lead and form a syndicate and made an alliance with others with mutual understanding.
#3 – Engagement Letter
After selecting the investment bank, an engagement letter will be prepared by both the party in which all the terms and condition are mentioned like all the out of pocket expenses incurred by the underwriter will be reimbursed by the issuing company, underwriter discount, which is the difference between the sale price of the share to the public and purchase price of the underwriter from the company.
#4 – Letter of Intent
Letter of intent includes the underwriter’s commitment as per the arrangement to the issuing company and commitment given by the company to an underwriter that the company will provide all the relevant information relating to this IPO.
#5 – Underwriting Agreement
After complete, all the above things underwriting agreement will be executed between the company and underwriter by which both the party will be contractually bound.
#6 – Registration Statement
The issuing company and underwriter will prepare a registration statement in which company history will be mentioned, like a financial statement of an earlier period, management details, promoters holding, legal issues, and any other information which may influence the investors. This registration statement needs to file to SEC (US Security and Exchange Commission)
#7 – Red Herring Prospectus
This is the first prospectus of the company prepared by the underwriter and includes all the company information. This document is prepared for investors who are willing to buy stocks.
#8 – Pricing Decision
After getting approval from the SEC company, and underwriter will decide the price of a share and the lot size which is offered to the public.
#9 – Opening of IPO
After finalizing the price, the company opens the IPO for the public, and generally, it will run 4 – 5 days.
#10 – Allotment of Shares
Af of the IPO Pe closingriod, shares will be allotted to the investor as per their bidding. It may be fully subscribed/undersubscribed/oversubscribed, in case of oversubscribed shares will be allotted to the investor on a pro-rata basis.
Eligibility Criteria to Apply for an IPO
- The company must have 400 or more shareholders who are holding 100 or more shares.
- There should be 1.10 million publically traded stocks.
- Share price at the time of listing should be at least $4 per share.
- The market value of shares should be at least 40 million.
- Aggregate profit before taxProfit Before TaxProfit before tax (PBT) is a line item in a company's income statement that measures profits earned after accounting for operating expenses like COGS, SG&A, depreciation & amortization, and non-operating expenses. It gives the overall profitability and performance of the company before making payments in corporate taxes.read more earnings of the last three should be $ 10 million, out of which the last two years pre-tax earnings should not be less than $ 2 million, and there should not be lost in any of the last three years.
- Market capitalization must be at least $ 550 million.
- Previous year revenue must be at least $ 100 million.
Why Does a Company Offer IPO?
- It helps in raising the fund because a large no. of the public will invest in the company by buying shares.
- It increases the company reputation, brand reputations, and market opportunity because more people will know about it.
- It helps in getting the loan with lesser interest costs.
- It increases the liquidityLiquidityLiquidity shows the ease of converting the assets or the securities of the company into the cash. Liquidity is the ability of the firm to pay off the current liabilities with the current assets it possesses.read more because any time shareholders can sell their shares, management/promoters can also easily sell their shares.
- It attracts employees also, and they will also get motivated.
Things to Remember Before Investing in IPO
- Company past performance and when the company has been established.
- How much of stocks are going to the public and how much they are going to keep with themselves.
- Who will be managing director and top management of the company, and how much is the experience to them.
- What is the vision & mission of the company from red herring prospectus? How is the company going to increase its profitabilityProfitabilityProfitability refers to a company's ability to generate revenue and maximize profit above its expenditure and operational costs. It is measured using specific ratios such as gross profit margin, EBITDA, and net profit margin. It aids investors in analyzing the company's performance.read more and share price of the company?
- What are the company product and consumption capacity of that product?
- What is the market share of the company?
Example
Let’s take an example.
Amazon IPO
- On 15th May 1997, Amazon went for an IPO and filed the registration statement to the SEC.
- At that time, Amazon was in the business of online retailers of books.
- On that year, amazon has around 250 employees, and their yearly revenue was $ 16 million.
- The initial public offering share price of Amazon was only $ 18 per share, and today’s amazon’s share price was $ 1,780.
- If we compare from IPO, then we will find that who has invested in IPO has got 100 times the invested money.
Conclusion
Companies are going for Initial Public Offering for raising funds from the public, and it provides various benefits to the company like increasing the valuation of the company, increasing their market shares, liquidity, product awareness among the public. At the same there are some disadvantages of IPO also like owners/promoter does not have the full control over the company because after a board of directors and shareholders will manage listing company are the owner of the company, and they can choose the directors who will run the company.
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This has been a guide to the Full Form of IPO – Initial Public Offering and definition. Here we learn how does it work along with its eligibility criteria and example. You may refer to the following articles to learn more about finance –
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