IPO stands for initial public offering of a company’s stock. When a private limited company issues an IPO, it offers its stock to the public for the first time. IPOs are issued by smaller companies for raising funds or expanding. Once investors subscribe to the IPO of a company, they become shareholders in the company.
Every public company listed on the stock exchange started with an IPO. However, before a company can list its stocks on an exchange via an IPO, it is required to fulfill a series of obligations, which can take from six months to a year.
How is an IPO valued?
An IPO is valued based on the demand and supply. Market analysts or experts determine the worth of a stock. Pricing is the trickiest part of an IPO. It should neither be overpriced nor underpriced. Because past performance or history data are not available for a stock offered in an IPO, various methods and techniques like financial modeling, comparable company, and precedent transaction analysis are employed to determine its value. If the stock is underpriced, the company has a long way ahead of itself to catch up on the gains. If it is overpriced, there will be a few takers.
A company, its auditors, accountants, lawyers, the Securities and Exchange Commission (SEC), and underwriters work together on matters such as deciding the quantity of stocks sold in the IPO, growth potential of the company, market trends, and customer demand to determine the value of the underlying IPO.
When the basic value of the company is estimated against the market value of the company, the value per share is fixed under absolute valuation. In doing so, estimated discounted cash flow and economic value of the company, such as residual income, assets, and outstanding debts are considered as well.
Relative value is arrived at by comparing the IPO-issuing company with other similar companies.
Before one decides to invest in a company through an IPO, several valuation-related factors must be considered.
- What is the purpose of issuing the IPO?
- What are the growth prospects of the company in question?
- How is the company going to utilize the funds received from the IPO?
After evaluating all the aspects of the company found in the S-1 statement, an investor can determine whether the company is worth investing.
How to invest in an IPO?
One can invest in an IPO through an exchange or a broker. Once an IPO hits the market, it is automatically listed at a higher price than the fixed price if the demand is higher than the supply. In that case, the IPO is oversubscribed.
The funds received from an IPO can be used for expanding, research, or even to pay off debts. In many cases, private investors or founding partners use an IPO as their exit strategy. Companies tie-up with investment bankers to handle and manage IPOs.
Investors can expect many fluctuations and a lot of volatility in the initial days of trading after an IPO is listed. Listing an IPO on the stock exchange is indeed a big step for a private company, which becomes a public company after the IPO.
