What is an IPO?
An IPO, or an Initial Public Offering, is when the public is offered shares of stocks of a company for the first time. Generally underwritten by investment banks, in case of IPOs, the same investment banks also make the arrangements for the shares to be listed on various stock exchanges. Through the process, more commonly known as “going public” or “floating”, a private company, with a limited number of shareholders who mainly comprise of primary investors (founders, their friends and families) and professional investors (angel investors and venture capital providers), transforms into a publicly held company.
IPOs are generally utilized to increase additional equity capital for the company going public. As a result of IPOs, raising future capital and/or the trade of currently existing holdings becomes significantly more convenient. The monetization of investments made by the private shareholders, also including the private equity investors, is made simpler by using the Initial Public Offerings.
Factors that Determine the Price and Performance of an IPO
It is essential that investors know more about the various factors that determine the prices of IPOs. Considering how Initial Public Offerings understandably run a higher risk rate than that of general trade of stocks, it is advisable for investors to thoroughly research the companies in question before trusting them with their finances. Therefore, an understanding of how the company in question intends to utilize the capital being raised becomes important. Investors are required to be aware of the financial history of the company, as well as its leading management, to get a good sense of how they might perform in future.
- Dynamics that Determine the Initial Price: In order to analyze the initial price range of the IPO, investors should be well-researched about the factors that the underwriter, which is an entity that is hired by the company going public to manage the IPO process (a position generally filled in by investment banks), has used to determine the rate of the IPO. The preliminary prospectus holds the details regarding the criteria that was fulfilled to arrive at the set price rate, which the investors are advised to go through. Also in the preliminary prospectus, there should be a detailed account of how much more market share the company can capture, as well as if any company executive has currently invested in the project. These factors will enable the investor to make an educated assessment about the reliability of the company. As an additional effort, investors can consider comparing similar companies and their stock values to the IPO in question, this may provide a very basic outline.
- Investor Sentiment Can Determine the Final Price: There are certain other factors that can determine the final price of an IPO, in that these factors can often lead to an increase or decrease in the final price. Immediately after a company publishes the preliminary prospectus and the initial price of the IPO, it will then try and bring up the value of the IPO, generally by promoting the IPO to big investors and investment institutions. The success or failure of the attempt to increase the value of the IPO will determine the final price. If the company can get possible investors sufficiently interested in the IPO, the growing demand can be utilized to raise the final price. Similar, if the situation is less favorable and sufficient interest could not be generated, the final price of the IPO will be accordingly devalued. Given that the investor’s interest and positive sentiments are essential factors that determine the final price of an IPO, companies often utilize additional tactics to attract investors. It is important for an investor to be aware of said tactics and make carefully analytical decisions based on their research.
- Risk is also an Important Determining Factor: It is mandatory for a company to provide a disclosure of their risk factor in the preliminary prospectus they publish. This contains a detailed account of the company’s risk profile, and investors are advised to thoroughly go through the risk profile and the available details. It is important for an investor to compare the risks and the potential earnings and make a decision that does allow one to outweigh the other. Governance policies are also an important part of a company’s risk profile. An investor must go through the companies proposed governance policies as well as the profiles of the companies leading management, this will give them a good idea of what they can expect from the company. If the company in question chooses not to include its policies of governance, an investor must be cautious and consider the increased level of risk as a result. When it comes to IPOs, an investor can make a tremendous profit, or even incur a significant loss. The result may not entirely be up to the investor but, it is their duty to be educated about the choices they make.
- Timing of the Issue of IPO: The correct timing is imperative when it comes to the launch of an IPO. There are certain very favorable periods of time when the launch of an IPO would be the most profitable for a company. If the company can go public at the “peak time”, it is guaranteed to receive greater valuations
In case of IPOs, given their nature, an investor can never be certain of the outcome. There are possibilities of significant profit along with the simultaneous possibility of suffering a loss. Despite the fact that the outcome cannot be pre-given, if an investor does their due diligence in terms of research, they should be able to make a safer and more educated decision regarding their investment. Therefore, it is essential for an investor to take time to thoroughly research the company they are looking to invest in, the time of the company’s IPO launch, the preliminary prospectus prepared by the company and all the details that it includes. If the investor is informed, there is always a higher chance of making a favorable decision.