An Initial Public Offer (IPO) is the first step for a company to get listed on the stock exchange. It entails the raising of funding from the general public; and is an offer for sale of a stake in the business’ profits, losses and growth strategy to the individuals who subscribe to the capital. By raising funding from the public, a company can reduce the leverage (proportion of debt financing), thereby improve its gearing levels.
The IPO investment strategy is chosen by business owners as a part of their overall vision and mission statement. Timing an IPO correctly is one of the major challenges that companies face. Often there is a lot of media noise before an IPO comes out. Industry analysts and financial experts give their opinions on whether the IPO must be subscribed to or not for future returns. Their opinions are based on the financial report of the company, the credit rating of the IPO issue, the information contained in the prospectus and the overall state of the particular industry and the economy in general. There are several advantages of adopting the IPO strategy for both investors as well as the company issuing the IPO.
Investors have many benefits of subscribing to an IPO. They get an opportunity to buy into a profitable stake of a company with expansion or growth plans. Here are the advantages to the investors:
- Growth stock investments: IPOs are usually conducted by companies that are emerging and which have a fresh business model or idea for expansion and diversification. These companies are termed ‘growth stocks’. Investors of an IPO get the opportunity to invest in these high yielding growth stocks.
- High returns probable: As mentioned earlier, growth stocks are high yielding and provide attractive returns in the long run. Even by a ‘buy and hold’ strategy, investors can earn a good return on investment by investing in growth stocks.
- Attractive buy prices: With an IPO, the company essentially raises funding from the public. It prices the shares based on a conservative and thorough analysis on the number of investors who would be interested in investing. Companies have to pitch their IPOs in the market to ensure a good response from the public. Investors have the advantage of buying shares at reasonably low prices, as compared to the shares that are traded on the secondary markets. This is an easy entry strategy for a buyer for high gains in the future.
- Customizable: Once an IPO stock is bought, investors have the option of earning short term or long term gains based on their own investment objectives. Certain investors buy and hold shares purchased in an IPO to gain long-run returns (position trading). Other investors track price movements and exit the investment in some time, for short-term gains.
Companies come with an IPO issue to raise funding for their business growth. It is an attractive method of raising capital as compared to raising debt, which has a high cost attached to it. The advantages to the company issuing an IPO are as follows:
- Raising Capital: An IPO issue ensures that capital is generated directly from the general public. A successful IPO run can do wonders for the expansion and growth of the issuing company. The money raised can be utilized for paying off debt, capital expenditures, research, and development or other strategic goals like expansion or diversification into other product categories.
- Strategic alignment: The issuer’s management strategizes the goals and objectives of the IPO issue, before the execution of the offer to the public. An IPO aids the company to reframe its long-term goals and future path for expansion. Growth companies come with IPOs to fund their business ideas and expand them to a larger market.
- Publicity: After an IPO is successfully conducted, the company gets listed on the stock exchange. During the IPO process, a large number of industry experts and financial analysts discuss and debate the viability and quality of the company’s stock; to aid investors in the decision of buying a stake in the IPO. This brings the company into the spotlight and generates publicity for itself. This is a major advantage for emerging and small-sized companies looking to build market recognition.
- Attracting talent: With the publicity and market attention, the issuer would find the task of attracting talent to the company easier. A qualified and robust workforce can be built based on investor confidence and market reputation. This would aid the company in the achievement of their business objectives smoothly.
An IPO is considered one of the best investment alternatives for investors, and also one of the best ways of raising capital from the market. Financing through an IPO is essentially a stake sale to the investors. This is not debt financing, and the cost of debt can be reduced to a large extent by the issue of shares to the public. A successful IPO run brings visibility in the market and goes a long way towards building trust and reputation for the company in the market. Investors benefit as well by gaining attractive returns in the long run. They also have a choice of either gaining short-term returns or long-term returns, based on their own investment goals.