Full Form of IPO – Initial Public Offering
The Full Form of IPO is Initial Public Offering. When a company first time offers to buy his shares by the public then it is called initial public offering for this company has to list his shares on a stock exchange first because the investor can buy only those shares which are listed on the stock exchange. By listing shares on a stock exchange and issue an IPO private limited company can convert into a public limited company. Companies are issuing IPO for raising funds from the market and in return investor 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.
#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 underwriter 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, 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 investor then underwriter will buy the remaining no, of shares and fulfill his commitment.
B – Best Effort Commitment
In this arrangement underwriter does not give any guarantee to the issuing company rather he will only help to sell the securities of the company.
C – Syndicate of Underwriters
In this arrangement, more than one investment bank is involved in selling the shares of the company 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 pocket expenses incurred by underwriter will be reimburse by the issuing company, underwriter discount which is difference between the sale price of share to the public and purchase price of the underwriter from the company.
#4 – Letter of Intent
Letter of intent includes the commitment given by the underwriter 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
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 information about the company. This document is prepared for investors who are willing to buy stocks.
#8 – Pricing Decision
After getting approval from 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 company opens the IPO for the public and generally, it will run 4 – 5 days.
#10 – Allotment of Shares
After the closing of IPO Period 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 tax earnings of the last three should be $ 10 million out of which 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 increasing the company reputation, brand reputations, and market opportunity because more people will know about the company.
- It helps in getting the loan with lesser interest costs.
- It increases the liquidity because any time shareholders can sell their shares, management/promoters can also sell their shares easily.
- 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 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 the company is going to increase the profitability 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?
Let’s take an example.
- 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.
- In Initial Public Offering share price of Amazon was only $ 18 per share and today’s share price of amazon 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.
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 listing company will be managed by a board of directors and shareholders are the owner of the company and they can choose the directors who will run the company.
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 –