Deciphering IPOs and the Primary Market

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  • 15 Mar 2023

When you first start investing in the markets, you are often bombarded with a slew of jargons. And, while it may appear difficult, a majority of it is simply related to understanding a company's structure and ownership.

A company, according to the classic definition, is an organization made up of assets such as capital, infrastructure, and people. A business purchases inputs such as raw materials and labor, as well as rents or purchases infrastructure, in order to produce outputs in the form of goods and services. Companies can either be:

  • Privately owned
  • Publicly owned and traded

Private ownership of a company implies it being funded by private entities. A publicly owned company is one which is at least partly funded by the public and traded on share markets. A person or an institution that funds a company is part owner of the company and is allotted shares of the company, bestowing voting rights on the shareholder. So a company may be fully owned by a single entity or multiple entities may own the company as part owners. The Company appoints a board of directors based on the majority vote of the shareholders. The board of directors is empowered to make decisions on behalf of the company. Now that you’ve got a cursory idea of how companies are owned, let’s look at what an IPO is and how it works.

But before we get to the how, let us first understand Why

All this while you may ask, why do I need to learn about IPOs. Primary markets in India are humming with initial public offers (IPOs), while secondary markets throughout the world are becoming volatile. Since September, the primary markets have largely turned bullish, making up for a drop in initial public offerings (IPOs) earlier in the year. The majority of the 15 companies that went public in the fourth quarter of 2022 have rewarded investors. While several investors in 2023, are raring to invest in IPO, there are still many who are gaining an understanding of the primary markets. So let us start from the basics.

In this article, the following points will be discussed:

  • What is an IPO?
  • IPO meaning and IPO definition
  • Types of IPO
  • Common terms associated with an IPO

An Initial Public Offer, commonly known as IPO, helps a private company transform into a public company.Informed investors aim to earn returns on investments with an IPO after a careful analysis of the benefits and risks. To join the league, let us begin by understanding the basics.

The Initial Public Offer or IPO is a process in which a private enterprise or a corporation agrees to sell a portion of its stake to outside investors to raise capital for upcoming projects or expansion, facilitate better functioning of current assets, and help monetize the initial investments. After the process of IPO is complete, investors can freely trade the company’s shares in the open market.

Book building offering and Fixed price offering are the most popular types of IPOs. In a book-building offering, bidding is involved since investors can bid before the enterprise decides the final price of shares. Generally, the company makes an offer of a 20% price band. The investors need to specify the amount they intend to invest and the number of shares they want to buy. Here, the highest share price is the cap price, and the lowest is called the floor price. The final call for the ultimate share price is considered based on the bids placed by the investors.

Contrastingly, in the case of fixed-price offering, the final price set by the corporation for the primary sale of their stocks. It is only known to the investors after the corporation decides to make it public. Investors willing to participate in the IPO must fulfill all the terms and complete the full payment during the application process.

Common terms associated with an IPO

  • Oversubscription When the number of shares applied by the investors exceeds the number of shares offered by the company, it is called oversubscription. Under subscription - This is the opposite of oversubscription. When the number of shares applied are comparatively lesser than that offered by the enterprise, the condition is said to be under subscription of shares. Issuer - The company willing to go public by way of offering part of its holding to investors is said to be the issuer.

  • Underwriter Underwriters commit the issuing entity that the remaining stocks from the final pool of offers, if not picked up by investors, will be subscribed by them. Underwriters can be anyone like a broker, financial institution or banker. IPOs are beneficial to the issuing entity and the investors. It helps the enterprise build prestige and expand their exposure in the market apart from increasing the equity base. Investors must identify the right opportunities by understanding the financial metrics to yield solid returns from an IPO.

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