Did you know that there were 369 companies that went public in the US alone this year? If you’re new to stocks, you might not be aware of the concept of 'going public'. Basically, private companies 'go public' to attract investors & investments. They do so by issuing shares initially to raise capital also known as an IPO.
Private companies going public is not a new trend in India. Let’s roll back the clock to 1977. Blue-chip IPOs started popping up in India because several MNCs had to dilute their equity.
These IPOs were regulated by the Controller of Capital Issues (CCI). At the time, let’s just say that you had a better chance of hitting a hole in one in golf than getting an IPO allotment. That changed in 1992 with companies being allowed to set their IPO price & quantum.
Let’s take a look at the finer details of IPOs and understand how they work so that you can keep an eye out for the best IPOs yet to be rolled out in 2020.
What Is The Meaning Of An IPO?
IPO is short for Initial Public Offering. A private company issues shares to investors outside the organization to raise more capital for the first time. By law, a company can only have a limited number of shareholders within the organization.
This changes when the company goes public. An IPO allows the company to trade on the stock exchange which helps them attract more investments.
Not every IPO can deliver returns like Google, Facebook, Amazon, or Alibaba. What’s more? If you’re a regular investor, you might not get the exact number of shares that you initially hoped for since most companies allot shares on a proportional basis.
Regulatory action & lock-in periods indicate that the risks of investing in an IPO far outweigh the benefits.
There are relatively better, tried and tested options for long term or even short term wealth creation like:
Investing in an IPO online needs to be backed by thorough research & diligent planning. With that said, let’s take a look at the process of investing in an IPO online:
1. Choose the IPO That you Want to Invest in
Gain confidence in the IPO. Read about the company, their future plans, their business model, how they are going to beat competitors, and more in the prospectus that any company offering an IPO publishes. Remember, there were 25 IPOs in 2018, 16 in 2019 and 13 currently in 2020. Picking the best IPO can be an eye of the needle sort of event.
2. Open The Required Accounts
You need 3 accounts to be able to invest in an IPO:
Bank account: To pay for the shares.
Demat account: To hold the shares in a dematerialized form.
Trading account: To buy the shares. Open this account at any brokerage firm or company that deals in share trading.
Investors tend to be allotted fewer shares than initially applied for. But it does so rarely happen that investors luck out and get the exact number of shares they applied for. In any case, you have to back up the shares by funding them in these ways:
With your savings
By taking out a loan
A handful of banks and Non-Banking Finance Companies (NBFCs) offer loans for IPO investments.
4. Follow The Application Process
You can either apply for the IPO through a trading account or certain bank accounts. Application Supported by Blocked Amount (ASBA) facility is mandatory to apply for an allotment in an IPO. ASBA allows banks to block the amount needed to invest in the shares that you are allotted.
How Does A Company Decide The Price Of The IPO?
The main goal for any company is to raise more money that can act as a catalyst for growth & revenue. Keeping this in mind, a company decides the price of its IPO in one of 2 ways:
1. By Setting A Fixed Price
The company decides a fixed price based on the capital that it wants to raise. This generally works well for investors because the price of the share is common knowledge. Depending on affordability & potential, investors may choose to invest in the IPO.
2. Book Building
This method generally involves the company figuring out the best share price over the course of the IPO. The IPO price is split into 2 price bands:
Floor price: Lowest price
Cap price: Highest price
The best share price is determined by asking investors to:
Specify the number of shares to be bought
State the price they’d be willing to pay for each share
By the end of this process, the company gains a solid idea of the ideal share price and decides on the final issue price.
While an IPO may seem like a horse race with bets flying everywhere, it's anything but. There’s a principled approach to identifying the best IPOs, bidding the right way & knowing when to sell.
Besides, there are risks like the timing of the IPO and the fact that the company offering the IPO will be at a nascent stage in their development. It may be a tempting proposition and of course, some IPOs may be bargain buys.
But jumping into an investment without considering factors like age, investment goals, financial health, and more can be detrimental. So it's recommended that you evaluate other investment options that can work for you.
Find out more about investment options like US stocks, Indian stocks, Alternative assets, and more by speaking to a wealth coach today.
Watch these video to know more about investment options better than an IPO:
1. US Stocks
2. Indian Stocks
3. Alternative Assets
1. What does IPO mean?
Ans. IPO is short for Initial Public Offering.
2. What is an IPO and why is it important?
Ans. An IPO is short for Initial Public Offering. It is important because an IPO allows a private company to raise funds from public investors. Once the IPO is complete, the private company becomes a public company whose shares are listed on the stock exchange.
3. Is IPO good or bad?
Ans. Investing in an IPO is a risky proposition because of the unknowns involved. Instead, there are investment options that offer benefits similar to an IPO like US stocks, small cap funds and small cap stocks that you can invest in using Cube Wealth.
Shriram is a Content Marketer at Cube Wealth, the Financial Freedom App with a smart Perfect Portfolio Planner. He has developed cutting edge IT products for over 2 years before turning to his passion for the written word. Shriram’s love for philosophy, product development, and empowering people through quality content is what got him to Cube Wealth.
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