What is an IPO?
Companies can be categorized into public limited and private limited. A private limited company has limited shareholders and generally not many details are known about the company. Going by its name, private companies do not offer their shares for sale or purchase. On the other hand, public limited companies will have to apportion certain segment of its ownership in the form of “equity” for public and also should trade its equity share through a stock exchange.
What makes companies to offer equity share to the public?
Companies often need to raise capital for its growth plans. Going to public seeking funds is one of the important ways of gathering funds. It simply implies offering ownership of the company to the public by inviting them to invest in its equity. The interested investors from the general public would then apply seeking allotment of shares of the company.
Let us try to understand what an IPO is.
The initial sale of stock that a company offers to the public is known as Initial Public Offering or IPO. Company uses IPO for raising the money for its expansion and any other such purposes. This method of raising money for the company is called equity form of finance. However, IPO is not the only route for the company to raise money for its activities. The companies can borrow money from the financial institutions and the banks in the form of a debt. But such form makes the company liable for debt repayment.
The “initial public offering” of the shares signifies launching of the company in to stock market where its shares shall be traded, understandably for the first time. With the IPO, the company transforms itself from a private limited company in to a public limited company. The company going “public” need not repay the money invested by the investors. In a public limited company, the investors will off load their shares in the stock market by trading. The stock market listing of the company makes it possible to trade their shares.
By going for an IPO, a company can enjoy several benefits than when it was previously a private limited company.
- It can enlarge and expand its equity base
- It enables the company to have cheap and easy access to finance which it need not repay.
- It increases its visibility, enhances its prestige and prestige.
- It helps company to manage its resources employees in a more responsible manner at it is answerable to its stake holders.
- It can retain its employees by offering ownership through employee stock option
- A public limited company can facilitate its easy acquisition in terms of distress.
- A public limited company has many ways to look forward to its finance in the form of rights issue, convertible debentures and many such other options.
- It also gives them access to cheaper bank loans through negotiations.
Company going for an IPO has its share of disadvantages. In the first place, the cost involved in the complete process and the need to offer the mandatory information related to the business to its prospective investors in the form of prospectus make them vulnerable. The prospectus is usually an extensive document disclosed by the companies who want to initiate an IPO. Investment banking companies or firms act as underwriter for devising the prospectus. Underwriters are well versed with the right assessment of the value of the share, creating a market for initial sale. This can put the company at risk. The information furnished in the prospectus of the IPO will be useful for the competitors who may create problems either in the form of competition or in the form of creating bottlenecks in its business by alluring the company’s prospective clients.
Once the company becomes public limited, it is governed by many rules and regulations formulated for its management by the government and to manage its share holders. It has to comply with the companies act and labour laws while dealing with its share holders and employees. It has to be operated by a Board of Directors who report financial details about the company every quarter. Public companies’ activities are scrutinized by board like SEBI in India.