What is an IPO, and what are its benefits?

Usually, companies start off by being private companies – startups, small businesses, partnership firms, etc. However, once they reach a certain level of growth, they may decide to go public, and they do so by launching an Initial Public Offering (IPO). But what is an IPO, really?

An IPO is when a private company offers its shares for the first time to the public and gets listed on the stock exchange. Through this process, the company transitions from being a private company to a public company and raises capital from public investors. IPOs benefit the company and investors in several ways and can be a great investment opportunity for you. 

How does an IPO benefit the company? 

Before a company issues an IPO, it has to meet all the requirements of the regulatory body in the country, such as the Securities Exchange Commission (SEC) in the US and the Securities and Exchange Board of India (SEBI) in India. It has to disclose all its financial statements, hire an investment bank as an underwriter, register for the IPO, create a detailed prospectus, etc. So, why would a company do all of this? Here are some of the primary ways a company benefits from an IPO:

1. Raising large amounts of capital 

One of the most common reasons a company issues an IPO is to raise capital or funds for growth and expansion. An IPO allows easier and greater access to higher amounts of money. Before an IPO, the way the company raises capital can be costly – either through loans from financial institutions or giving up large portions of equity (ownership) to private investors. 

2. Exit opportunity for founders and early investors 

Before a company goes private, its equity or shares are held by its founders, early private investors, and employees who receive stock options. But as long as the company remains private, these shares cannot be sold like ordinary shares in the stock market. Hence, when a company goes public, it gives an exit opportunity for founders, private investors, and employees to sell their shares and gain liquidity. 

3. Increased credibility and branding

When a company launches an IPO, it receives significant publicity and promotion. In addition, because the company has to register for the IPO with the respective regulatory body and make extensive financial disclosures, this increases transparency, leading to greater credibility. 

So, an IPO greatly benefits the company. But what about you? Is an IPO just as beneficial for investors? Let’s find out.

How to benefit from an IPO as an investor?

Typically, you can invest in a company’s stock soon after its IPO through an app for the share market.

IPOs are as trendy in the world of investing as Tiktok is in the world of social media. Many investors see IPOs as tremendous money-making opportunities, and they surely can be in some instances.

For instance, Apple went public on December 12, 1980, at $22 per share. If you had invested in its IPO at the time, and were still holding the investment today, over the 42-year period, you would have made 1,42,537% returns, or about 18.8% returns on an annualised basis. Compare this to the S&P 500 returns over the same period, 2,716% or 8% on an annualised basis, and you know Apple’s IPO investment is a winner. 

So, IPOs offer the chance to invest in companies with high potential at an early stage at a low price. When you invest in the IPOs of such companies, you are setting up your investment portfolio for significant capital gains over the long term. However, it’s important to note that not all IPOs perform well. For instance, One97 Communications, Paytm’s parent company, which was one of the most anticipated IPOs in 2021, has fared to be one of the worst-performing IPOs, slumping about 75% from its IPO price by the end of 2022.

Despite that, a lot of IPOs have proven to be great investment opportunities for retail investors. Over the last decade, two-thirds of the companies that launched IPOs in India have generated positive returns, according to Prime Database. And a lot of the IPOs listed in 2022 have gained over 400% since listing. Hence, it is a smart decision to consider investing in upcoming IPOs. 

What to know before investing in an IPO?

Just because a company seems well-established or is a popular brand doesn’t mean its IPO will perform well. There are a few crucial things you should check before deciding to invest in an IPO. 

One of them is what purpose the IPO funds will be used for. If they are used to pay back debt instead of for growth and expansion purposes, it might not make for a good investment. Another thing to understand is the company’s risks, opportunities, and business model. For this, carefully reading the IPO prospectus is important. It contains all material information regarding the utilisation of funds, potential risks for investors, promoter and management background, etc. 

In case you missed investing in the IPO of a promising company, all is not lost. You can still invest in its shares soon after, once you realise it makes for a good investment opportunity. And of course, accessing high-performing stocks from across the globe has never been easier!