What Is An IPO And Why Do Companies Offer It?

What Is An IPO And Why Do Companies Offer It?

Let’s just say that Zomato’s IPO offering has been a living room conversation for a while. People who applied for the IPO, can’t stop talking about it considering the number of short-term capital gains they made.

Why not, I’d do the same if my investment had grown almost 100% in a span of 10 days. No, this is not getting rich in 21 days scheme but a purely legitimate business transaction.

Having said that, most people don’t understand what an IPO is and how it helps anybody and why all the mad rush.

Yep, this is exactly what this blog is about. I will try to explain this concept in the simplest of ways.

What Is An IPO?

IPO stands for Initial Public Offering. It means that a private company is now willing to offer its partnership in the form of shares and turning itself into a Public Company.

By offering its shares to the general public and private investors, the company raises capital to fulfill various capital expenditures and use some of the capital to secure their previous investors and rest towards developing their business for the next level up.

It’s not an easy gig to just show up to SEC and ask to be listed. A company needs to be at a unicorn stage. That means that their private evaluation should be over $1 Billion Dollars. In addition, they need to submit all the fundamental documents to SEC that confirm and assure them that future investors can be protected from bearing severe losses.

Besides submitting documents related to their financial health, they are also required to share the future plans of how they plan to use the raised capital. This is important for SEC to make a decision on whether to allow a company to offer its IPO.

There Are 2 Types Of IPO Issues

1. Fixed Price Offering:

This simply means that the company determines a fixed price per share. A person buying the shares is fully aware of the exact price they are buying.

2. Book Building Offering:

Under this concept, the company offers to release its IPO in a Price Band. For Example, when you bid for an IPO allotment, you can request to buy between 72-76. The actual price that you got the allotment for is disclosed when the bidding is completed and ready to be published.

Why Do Companies Offer It?

Some companies reach a point where in order to grow they need to raise a huge sum of capital. One of the alternatives is to raise funds through Private Lenders. That turns out a very expensive affair and not typically a suitable approach. Especially, if the company has long-term plans and has achieved great milestones while being a private company.

On the basis of the company’s current financial evaluation, a certain price is assigned for a single unit of share. To put things in perspective, Zomato offered 719 Million Shares at a price band of 72-76 INR per share. You can do the math here.

This is huge equity capital for a company and they can put that money to good use. If the partners in the company continue to have a strong focus on the business, this capital raised can simply take the company to the next level.

Does It Help The Public?

Usually, a small percentage of their shares are offered to the general public. It varies from company to company. There are Institutional buyers such as Insurance Companies, Mutual Funds Companies, Brokers, Hedge Funds, and International Investors.

In most of the case, this is a win-win opportunity for both the company and the new investors.

Let’s go back to Zomato again. The minimum investment required to buy their IPO Shares was 195 Shares at a price of 76. However, when their shares were listed on the exchange they opened at a price of ₹131. In the next couple of days, they reached an all-time high of 147 per share.

This is actually huge, your minimum investment just doubled in less than 10 days.

This is a Share Premium that is often expected with new listings.

Not all IPO Issues will open at such a high premium, it’s important to do your due diligence. The stock market can get really tricky, the more the research the better you are.

Final Words

In conclusion, as I mentioned before, this is a great win-win opportunity for everyone to make a fairly decent percentage of profit. However, do not just bid for an allotment, research about the company history, their assets, debts, revenue, and profits earning.

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