In an IPO, a company announces an initial public offering. Thus, a private company that is not listed on any stock exchange starts selling its shares to the public for the first time. After IPO, the company can raise money through the sale of shares, and people can trade the shares of the company freely in the open market.
Many small enterprises, and startups use IPO to expand and advance their business. Companies can acquire funds from investors and use them to finance research, company expenditures and explore other opportunities.
IPO is a challenging process for the company because it has to gather a ton of paperwork to satisfy the conditions required by the Securities and Exchange Commission (SEC), which oversees public companies. Due to so much work, a private company usually has to hire an underwriter, an investment bank, that can guide on the IPO-related issues like setting an initial price for the offering, preparing key documents for investors, and scheduling meetings with potential investors.
There are two types of initial public offering (IPO):
1. Fixed Price Offering
In the fixed price offering, the company offers initial shares to investors at a fixed price. In this type of offering, investors can know the cost of each share even before it goes public.
For instance, a company that has been in the business for several years wants to expand its business by raising capital. The company can choose to use equity financing. Thus, the company starts to sell shares of the company’s stock, which is the IPO route. They hire their merchant banker, who evaluates and deduces the company’s level of risk. After the company and merchant banker prepare all documents following The Securities and Exchange Board’s guidelines, they receive a green signal for IPO. During the process, the company and merchant banker determine the price for each share to raise enough capital. For instance, the stock’s actual value can be $100 while the public price could be decided at $200.
2. Book Building Offering
In a book-building offering, the price of the IPO is not set by the company. Before the company decides the price, investors have a chance to bid within a specific time. However, the bidding is done within the lowest price and the highest price set by the company. Additionally, the company needs to mention how many shares it plans to sell. The company will accept the most reasonable price and decide the final price for the share.
Let’s assume the company plans to issue 10,000 shares in the IPO. The company offers a price that ranges from $10 to $15. And investors may send in their bids within a certain period. Clients’ suggested price can be $10 for 5,000 shares, $15 for 6,000 shares and 12$ for 4,000 shares. In this case, to issue all 10,000 shares, the minimum price will be $12 because the company received bids for 6,000 and 4,000 shares (which adds up to 10,000 shares) at or above 12. As a result, the company will refund money to individuals who bid at $10, and it will refund the balance amount to people who bid at $15.
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