Finance

Initial Public Offering – Types, Advantages and Disadvantages

by Ratul Sinha

What is IPO or Initial Public Offering?

Initial Public Offering or better known as IPO is the event of Private LTD. business going public for the very first time. Generally, businesses start as being owned by a few individuals with only the capital held by each of them. But as the business grows and there’s a need for additional capital, going public is one of the ways companies raise capital.

Types of IPO or Initial Public Offering

There are two types of IPO. Those are discussed below.

Fixed Price Issue

In this issuing process, the issuing entity along with their underwriters comes up with a price per issue that they want to sell their securities at. They do so by evaluating their assets, liabilities, and other aspects. The price is fixed on the very first day of issuing and is printed on the order documents. The order documents have to justify the price that the business is asking for by showcasing a realistic estimation of the demand of the stocks they are going to issue. But as there is no information on the real demand of the stock before the issue ends, oftentimes there is over-subscription for the securities. Fixed Price Issue can’t always come up with a fair price for the market. As there is always a chance to under or over evaluate the price of the issue than the market price for similar offerings. The investors have to pay up the full price of the security in advance.  Because there are just too many variables in fixing a price and then justifying it without having a certain idea of the demand, a Fixed Priced Issue is preferred less by the issuers. It is more suited to the more mature businesses that already have a well-established demand out in the public.

Book Building Issue

On the contrary, the Book Building Issue has no fixed price in the beginning. The price is established throughout the process of IPO. Though the price isn’t fixed, there is a range, between the price that can land on. It is called the price band. The least in the price band is called “floor price” and the highest is called “Cap Price”. This Price Band is printed in the order documents as the IPO progresses. The investors than can bid on prices on the number of shares that they want to buy. The demand is known as the bids are received every day. And as the price is not fixed beforehand, there is a much greater chance of landing at a fairer price compared to the market price of similar offerings. Having its flexible pricing method and a clear sense of demand for the issues, the Book Building Issue is the most preferred method so far.

What are the Advantages and Disadvantages of IPO if a Company Wants to Go Public?

Advantages of Initial Public Offering

Though businesses can raise funds for their operations by taking loans, making investments for private investors, or even being bought out by other similar companies, IPO remains one of the most preferred methods of collecting funds for its inherent advantages. By becoming a public entity, businesses get recognized throughout the corporate realm resulting in a much greater possibility for its growth. As it becomes very easy for businesses to get financed not only by the initial offering but also by secondary offerings. As a publicly-traded company needs to go through a rigorous qualification process, its credibility is enhanced to the public and other financial entities. Resulting securities of the investors get much greater liquidity because the investors are generally positive towards IPOs. Going public can also attract new talents to be hired for the company. Acquiring and merging with other businesses becomes very efficient for Public companies. If any of the owners desire to leave the operations, he/she can sell their part of the security to the public or other investors as an existing strategy.

Disadvantages Initial Public Offering

Even though IPOs seem to make the most sense for a company to raise the most fund it also has some disadvantages with it.

Firstly, going public means to have all the financial information out there in the general people’s hands even to the competitions.

Secondly, the process of IPO it the most rigorous and costly out of all the possible ways to raise funds. Also, the new owners may not always agree with the decisions made by the initial owners. The management also sees an overhaul to keep up with the new operations to maintain the Public LTD. regulations. If not, then the business might have to face some serious legal situations.

And Lastly, it’s not always guaranteed that the business performs optimally under new circumstances resulting in falling of its stock price.

So, IPO is surely a lucrative alternative to a growth-driven business looking to raise capital or oven getting recognition among the business world. But it does have its obvious downsides as it becomes rather costly and time consuming for a business to meet all the requirements to go on and issue publicly. And that’s why companies should consider both pros and cons before jumping on the Public LTD bandwagon.

Related

Resources

  • https://debitoor.com/dictionary/ipo
  • https://www.torys.com/pages/trends/the-benefits-and-costs-of-going-public
  • https://www.quora.com/What-are-the-different-types-of-IPOs-issued
  • https://caknowledge.com/fixed-price-method/