Investment word of the day: Initial public offering — why do companies go public? IPO process, types and more

Investment word of the day: Companies may often need to raise funds for multiple purposes, such as expansion, clearing debt or meeting working capital requirements. Out of the several options to raise funds, some companies opt for an initial public offering (IPO), which marks a significant transition for them.

What is an IPO?

An Initial Public Offering or IPO is a process by which private companies offer shares for the first time to the public. Through an IPO, a private company becomes listed on the stock exchanges and becomes public. IPO is often referred to as ‘going public’ because a company transitions from private to public ownership. Following an IPO, the shares of the company are traded on the stock exchange.

How is an IPO offered?

Issuing an IPO involves multiple steps, including an investment bank, regulatory compliance, and the public offering of shares. A firm hires an investment bank, which then helps determine the offering price and number of shares. The investment bank acts as an underwriter.

Following this, the firm files the registration statement and the underwriting agreement with the Securities and Exchange Board of India. The market regulator examines the documents carefully. Once approved, the date of issue of the IPO is declared.

Types of IPO

There are two types of initial public offerings — fixed price offering and book building offering.

• Fixed price offering: A fixed price IPO means the company sets the price for its shares before offering them to the public. It is determined with the help of underwriters by considering the financial aspects of the company.
• Book building offering: A book building IPO means the price of the shares is decided based on investors' bidding. The company reveals the price band, highlighting the upper limit, also known as the cap price, and the lower limit, which is the floor price. Bidding is done according to the price band.

Why do companies go public?

One of the major reasons a company issues an IPO is to raise funds, which can be used for growth and expansion. Subscription to an IPO provides significant cash flow to the company to meet its financial requirements. Additionally, these funds can help reduce the company's debt burden.

Disclaimer: This article is for informational purposes only and does not constitute financial advice; please consult a qualified financial advisor before making any financial decisions.