What is an IPO? How does an IPO work?

What is an IPO?

An initial public offering (IPO) or stock launch is the process of offering shares of a private corporation to institutional investors and retail (individual) investors in a new stock issuance.

IPO can be used to raise new equity capital for companies, to monetize the investments of private shareholders such as company founders or private equity investors, and to enable easy trading of existing traders or future capital raising.

How does an IPO work?

Before an IPO, a company is considered private. As a pre-IPO private company, the business has grown with a relatively small number of shareholders. When a company has matured to the point where it can handle the responsibilities of being publicly traded and is looking to benefit from the prestige, added volume, and exposure from an IPO, it starts to show interest in going public.

An IPO is a big step for a company as it gives the company access to raise a lot of money which provides the company with a more remarkable ability to grow and expand. To seek out larger borrowed funds as well as obtain better sources, the company also needs to increase its transparency and share listing credibility.

Going public is a challenging, time-consuming process that most companies can navigate alone. A private company planning an IPO needs not only to prepare itself for an exponential increase in public scrutiny but also has to file a ton of paperwork and financial papers to meet the requirements of the Securities and Exchange Commission (SEC).

The investment bank or an underwriter is chosen based on its reputation, research quality, industry experience, distribution (i.e., whether the investment bank can provide issued securities to more institutional or individual investors), and the firm's previous association with the investment bank.

These underwriters help manage every aspect of the process, including preparing for the filing, sharing documentation with regulators and the public, due diligence, marketing, how coins will be issued, and at what price. This process, colloquially known as floating, or going public, transforms a privately held company into a public company.

When a company goes public, the previously owned private share ownership converts to the public right, and the existing private shareholders’ shares become worth the public trading price. Share underwriting can also include special provisions for private to public share ownership.

Although IPO offers many benefits, there are also significant costs, chiefly those associated with the process, such as banking and legal fees and the ongoing requirement to disclose necessary and sometimes sensitive information.

Details of the proposed offering are disclosed to potential purchasers in a lengthy document known as a prospectus. Most companies undertake an IPO with an investment banking firm acting as an underwriter. Underwriters provide several services, including help with correctly assessing the value of shares (share price) and establishing a public market for shares (initial sale).

Alternative methods such as the Dutch auction have also been explored and applied for several IPOs.

IPO vs. ICO

Projects can raise money publicly through an initial coin offering (ICO) and an initial public offering (IPO).

ICO (or Initial Coin Offering) is a fundraising method used by early-stage startups in the crypto market.

IPOs typically belong to more mature, established businesses. Stronger accountability and far harsher regulations apply to IPOs.

In the cryptocurrency industry, ICOs have become very popular. They are typically carried out by a small group of people who have a great concept that they want to succeed. They appeal to the same demographic as Kickstarter and are a kind of crowdfunding. Investment in an ICO carries a substantially higher risk because the regulations governing them are still being defined.

Even though it is not acquired by law, a team seeking to acquire capital through an ICO typically begins by creating a white paper describing their concept and business plan. After that, a project raises money by offering its cryptocurrency tokens for sale.

A platform like Ethereum is used by organizations that want to generate money through an ICO to build their cryptocurrency token. The regulations for the tokens, such as the total quantity, the method of distribution, and any other unique circumstances, would also be written.

As soon as the token is created, the platform acts as a registrar for all subsequent transactions.

Why do companies want to go public through IPO?

When a firm lists its securities on a public exchange, the money investors pay for the newly issued shares goes to the company (primary offering) as well as any early private investors who choose to sell all or part of their holdings as part of the more significant IPO (secondary offerings).

One of the main reasons many businesses aspire to go public is the chance to raise potentially sizable amounts of capital from the market quickly. A firm can issue an initial public offering (IPO) to a large pool of potential investors to raise money for working capital, debt repayment, or future growth.

A business that sells common shares is never obligated to pay back the money it receives from its public investors. To price and trade their shares, these investors are forced to put up with the irrationality of the open market.

When shares are traded in the market after the IPO, money is exchanged between public investors. The IPO gives a chance for early private investors who decide to monetize their investment by selling shares as part of the IPO process. This simplifies acquisition transactions (share conversions) and raises the company's exposure, reputation, and public perception, which can boost sales and profitability.

Limitations of IPO

Companies may encounter several drawbacks to going public and may decide to adopt alternative tactics. One biggest drawback is the high cost of initial public offerings (IPOs) and the ongoing and frequently unrelated costs of sustaining a public company.

An IPO launch is not a simple procedure. It requires several steps, including choosing investment bankers, doing roadshows, setting share prices, getting SEBI's clearance, and finally going public. It is a protracted and essential process that requires oversight at every level.

An IPO entails up-front expenses that are required. Some of them include underwriting fees, legal expenditures, accounting fees, registration fees, advertising expenses, etc. These are nonetheless necessary and aid in completing the procedure appropriately.

Keeping competent managers who are prepared to take chances may be more challenging if the board of directors has rigid leadership and governance. It's always possible to keep things private. Companies may also request bids for a takeover rather than going public. In addition, businesses could look into several alternatives.

For management, which may be paid and assessed primarily on stock performance rather than actual financial results, fluctuations in a company's share price can be a distraction. The business must publish financial, accounting, tax, and other business data. It might be forced to publicly divulge trade secrets and business strategies during these disclosures, which could give rivals an advantage.

Unlike private businesses, public firms are required to file their financial statements annually. It suggests that the company should create an audit committee, financial reporting team, and more stringent financial controls. The corporation now owes its investors an explanation, which raises the possibility of substantial reporting charges.

What does it mean when a company "goes public"?

When a firm satisfies the requirements for public reporting responsibilities set forth by the Securities and Exchange Commission (SEC), it becomes publicly traded. Selling privately owned shares through an offering like an IPO, satisfying the SEC's investor base requirement for public reporting, or voluntarily registering with the SEC to disclose particular business and financial information to the public are examples.

Going public is a big decision that takes a lot of planning, regardless of the method. A corporation becomes subject to stringent reporting obligations once it goes public, as well as scrutiny from the shareholders who now possess a stake in the business.

Public company reporting requirements include:

• Quarterly and annual financial statements.
• Significant events that shareholders should know about.
• Proxy statements that describe the matters shareholders can vote on.
• Disclosures about proposed mergers, acquisitions, and other transactions.

How do companies go public?

IPO

Initial public offering (IPO) is one of the most prominent approach for a company to involve in the large investment pool of the market. Numerous stringent restrictions for businesses follow the lengthy process of an IPO. A typical IPO takes six to twelve months to complete.

The first stage of an IPO is when the company starts to get ready and does a readiness evaluation to find any problems. At this point, the company employs an investment banker, decides on its objectives, develops a schedule, and does other things.

The business then starts carrying out the strategy it created during the first phase. Companies are currently compiling the information required for registration and drafting all of their legal documentation.

The listed business enters a quiet period once it submits an application for registration with the SEC and waits for the SEC to approve its IPO preparations. The SEC permits corporations to communicate about other issues, including revealing accurate business information, during this time when IPO information release is restricted.

The company's shares can start trading after receiving approval from the SEC and satisfying the listing criteria of stock exchanges. Now that the IPO is over, the business is legitimately a public corporation.

Direct listing

A direct listing is a relatively recent method that businesses can use to become public and raise money without an IPO. Bypassing the customary underwriting procedure, a firm can become public through a direct listing.

In contrast to an initial public offering (IPO), where investment bankers are responsible for price discovery for the shares to be sold and more prominent investors typically receive preferential treatment for allocation of shares, on the day of the direct listing, shares of the company become available to be bought and sold on the stock exchange by any investor. The price discovery occurs through the buy and sell orders on the exchange, without any bank underwriting.

This kind of public sale of shares makes it easier for more investors to buy stock in the company, which helps level the playing field.

Companies like Spotify, Slack, and Coinbase have recently chosen direct listings as their method of going public.

The recent direct listing approved by the SEC was not a unanimous decision. In a joint statement, two commissioners expressed their opinion that excluding underwriters from the IPO process removes a layer of due diligence that safeguards investors' interests. If you intend to buy shares through a direct listing, proceed cautiously.

Reverse merger

A reverse merger occurs when a private firm merges with or is acquired by an existing publicly traded corporation to go public.

The acquiring firm in a reverse merger is typically a shell business or an acquisition company with a specific purpose (SPAC). Although the technique has been around for a while, it has recently grown in favor because some market participants feel it allows more control over deal terms and pricing than a conventional IPO.

A SPAC is a business that lists on the stock market but has no active operations or goods to sell. The company makes an initial public offering (IPO) and then utilizes the funds earned to merge with or purchase an already-existing private company.

Following the merger, the private company's management assumes control, while the newly formed company continues to run the previously private company's operations. For instance, the sports betting company DraftKings merged with the publicly traded SPAC Diamond Eagle Acquisition Corp in April 2020, and as a result, its shares are now traded on the Nasdaq Stock Market.

Because the private firm can merge with an existing company rather than start the whole IPO process from scratch, a reverse merger frequently represents a faster and less expensive way to go public.

Companies that had or will have their IPO

Coinbase IPO

Coinbase is a US-based cryptocurrency exchange. The IPO of Coinbase occurred in April 2021. The company's valuation at the time of IPO was up to $100B.

Coinbase's share price began at $381 per share, increased to $430, dropped back to $320, and finally stabilized at around $230.

BlockFi

BlockFi is a crypto-focused lending platform. BlockFi has revealed its intention to hold an IPO within the following year. Through 4 Series rounds, BlockFi has raised more than $400M.

Kraken

Following the successful launch of Coinbase, Kraken has decided to go public in 2022.

Kraken CEO Jesse Powell is still unsure of the exchange's listing process. Powell is uncertain about the future of Coinbase due to the stock's volatility. Kraken will keep an eye on the bitcoin market and base its judgments on its performance.

IPO Alternatives

When a company decides it’s going public, there are a few different routes it might use:

Venture capital

Many businesses wait until they are well-established and have a tested business model before issuing public shares. But in the beginning, they might still require funding to get started. Some businesses don't wish to make themselves available to public ownership, even at later stages.

Instead, many businesses rely on venture capital, a form of private funding where investors and venture capital organizations invest in private enterprises, frequently in exchange for a share of ownership. Startups and IT companies favor venture money.

Many well-known companies got their big break with the help of venture capital, including Twitter, Uber, and Airbnb. They are all now publicly listed companies.

If the business is in a more mature phase of its operations, it may also raise money through a private equity deal that includes a combination of loan and stock.

Reinvestment

Successful businesses can reinvest their profits to continue expanding. Reinvestment is advantageous because founders don't need to worry about losing ownership of their business or taking on debt to grow. Reinvestment isn't always a possibility, though. Companies that are just starting or with small profit margins will probably need to look at other solutions.

Borrowing

Borrowing is another method that businesses employ to access funds. There are primarily two ways for businesses to borrow money. First, companies can borrow money from banks in the same way that an individual can.

However, businesses can also use bonds, a popular method with government organizations. A corporate bond is a type of financial asset that enables companies to obtain financing from private investors. Throughout the bond's existence, the issuing corporation pays interest to the bondholders. The corporation then pays the bond's full face amount when it reaches its maturity date.

Companies may find bonds appealing since they retain ownership, but they also have to pay back the borrowed money, which is not the case with publicly issued shares.

Is IPO safe and legit?

As with any form of investing, participating in an IPO includes risks, and there are arguably more hazards with IPOs than purchasing the shares of established public firms. Bonds may be appealing to corporations since they don't surrender ownership. Still, investors are making decisions with more unknowable variables because there are fewer data points available for private enterprises.

Despite all the benefits of profiting handsomely from IPOs, many more work against them. More than 60% of IPOs between 1975 and 2011 experienced negative absolute returns after five years. On the other hand, a business might not be a wise investment at an inflated IPO price.

Conclusion

IPO has currently becoming popular among most investors around the world. However, it's fact that each mean of investment strategy has its own benefits as well as drawbacks, please do your own research carefully before investing!