Stock Market Basics Chapter 3. IPOs

 

So after a six months of long break, I am back!

I have talked about the reason behind my absence in another blog, which you can read here. But now let's talk about where we left the series, The IPOs.

So, as I said in the previous chapter, the IPO is short for Initial Public Offering.

It is when a company decides to go public for the first time.

Today we'll see the reasons companies go public and the advantages of going public and how it's done.

Reasons Companies go Public.

Now there are three main reasons why companies decide to go public:

• To raise funds to meet CAPEX.

As we know, CAPEX stands for Capital Expenditure. It is the expense evaluated by the company for long term planning. Many companies go public so they could get the funding for these expenditures. 

• To avoid debt.

To meet this CAPEX, many companies take a loan from banks. But a loan means you have to return the money. And if an entrepreneur is already in debt, they try to see other ways to raise funding for their company and, in such cases, IPO is a viable and easy option.

• The risk is distributed.

When you buy a share of a company, you own a part of that company. It means you're taking the risk of baiting on that company just like the entrepreneur. Of course, it depends on how many shares you buy. When you buy a share, you also buy the risk. That is why many companies go public. This helps the entrepreneur to distribute the risk in a larger number of people.

And that is why companies go public.

Aside from these, there are other advantages of going public, mainly for the early investors, employees and the company itself. Lemme explain.

Advantages of going Public.

For early investors: When a company goes public, it helps the early investors to exit the company with profit. Every time a company goes public, most of the early investors sell their shares. These could be VCs who invested in the company in the early stages. Or Angel investors who invested during the pre-revenue stage of the company.

For Employees: When a company goes public, it rewards its employees with an allotted amount of shares for free. Now this means they get free shares, they do not invest their own money. Which is very interesting, because if you invested nothing in a share that you own, doesn't that mean you are always in profit, unless the share's value drops into minus?

For the company: An IPO can improve a company's visibility. Going public is a great way of promoting your company and its product/services and then get paid for it. It is a cheap, effective and an interesting way of promoting your company.

How to go public? The IPO Process.

 Now the IPO is a long process. It starts with:

Step I: Appointing a merchant banker.

The first thing you need to do to go public with your company is to hire and appoint a merchant banker. They are also called "Book Running Lead Managers" (BRLM) or "Lead Manager" (LM). The BRLM helps you:

• Conduct Due Diligent
• Ensure Agreements are rightly done.
• Issue Due Diligent Certificate
• Prepare Listing documents such as DRHP or Draft Red Herring Prospectus
• Underwrite Shares
• Help the company decide the price band.
• Help with the promotion and marketing of the IPO
• Appoint Registrar, Bankers, Advertisers, etc.

Once the LM is appointed, the company can move on to:

Step II: Apply to SEBI and wait for the permission to go public.

The Merchant Banker has to send an application to SEBI with a registration statement. A registration statement is a paper that states what the company does, why it wants to go public, its financial standing, etc.

Once SEBI has all these records, it decides, after a careful consideration, whether the IPO should go ahead or if it's a no go. And if the company gets a nod, they should prepare a DRHP.

Step III: Prepare a DRHP.

A DRHP is a document that contains information about the IPO in detail. Information such as, 

• Estimated Size
• Estimated Number of Shares
• Reason for the company going public
• How will the company utilise the funding that will be raised from the IPO?
• Description of business model, revenue generated, expenditure, etc.
• Financial Statement.
• Management discussion and analysis.
• Risks
• Detail and Background of the Management.

This is prepared for the investors. They make this document public and it helps the investors make up their mind. So, yeah, it's a very important document.

Step IV: Marketing.

Just like everything else in our world, it is important you market your IPO. It can be done through social media, television, printed ads, or text messaging your customers. Now this process is called "Roadshow."

Step V: Fixing the Price Band.

What is a price band? Let's answer that first, a price band is an upper and lower limit for the IPO's price per share, by which the company will go public.

When deciding the price band, it is important not to go more than what the public is expecting the price band to be, or it will push them away and they won't subscribe to your IPO.

Step VI: Book Building.

Now once the price band is decided, and the roadshow is done. The Company can officially open the window and let the investors decide what they think is the right price for the share and buy them. The company collects these price points with the respective quantity and this is called Book building. It is an effective method to discover the IPO price.

Step VII: Closure.

The IPO stays open for a few days, then the window is closed. After that, the company decides the price point at which the issue gets listed. It is decided based on the price point with the highest bid.

Step VIII: Listing.

Then finally comes the day of listing. On this day, the company is officially listed on the Stock Exchange.

Aftermath of IPO.

On the date of issue, investors bid on the shares at a particular price within the price band, this is called Primary Market. 

Then the share is listed on the stock exchange and is now available for trading publicly. This is the Secondary market.

Basically, the initial bid on an IPO happens in a Primary Market, this is where the shares value is decided. The Stock exchange is the secondary market, where the share price is pre-decided, yet it relies on the market atmosphere. 

So that's all you need to know about IPOs.

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