IPO Advantages and Disadvantages

03 Oct, 2021

7 min read

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An initial public offering (IPO) is the process through which a company goes public by selling its stock to retail and institutional investors. Looking to buy IPO Stock? Understand some important points about them before investing.

Introduction

Often referred to with the acronym IPO, initial public offerings have surged in popularity in the last decade with some companies acquiring cult-like status owing to the way in which their IPOs were received. Coal India’s IPO of 2010 and Reliance Power’s IPO of 2008 serve as prominent examples here with the former having an IPO value that amounted to INR 15,200 Crore while the latter had an IPO valuing INR 11,700 Crore. With Paytm set to cross these valuations, it is important to have an understanding of the advantages and shortfalls associated with initial public offerings.

Defining an IPO

An IPO or initial public offering can be understood to be the process by which a private corporation offers their shares to the public in the form of the issuance of new stock. By doing this, the company in question is able to raise capital via public investors. By transitioning to a public company, private investors are able to realize gains from their investment in their entirety. IPO benefits for investors lie in bearing witness to its future expansion and potentially benefiting from the same.

There exist a wide range of advantages and shortfalls associated with investing in IPOs. Read on to understand the same.

Listing IPO Advantages

Fundraising – Serving as the primary advantage of an IPO, the proceeds raised via an IPO alone justify the decisions companies make to go public. This is owed in large part to the ample opportunities for investment now possible due to the influx of capital. Said funds are capable of benefiting a growing company in innumerable ways. Research and development, new hires, infrastructure, debt reduction, financing capital expenditure, new technology additions are just some of the ways in which IPO funds can be directed.

Exit Opportunity – All stakeholders that contributed their time, finances and resources to build their company from the ground up can finally potentially realize their expenses. IPOs provide stakeholders with the opportunity to exit with potentially vast sums of money. Else, they can liquify the capital they have invested in the company. It is worth noting that should founders and initial investors seek to receive liquidity from an IPO, they must sell their shares of the now public company.

Publicity and Credibility – Should a company hope to grow, it will need to amplify its publicity and exposure to would-be customers who can learn more about the company and its products. IPOs provide such companies with the limelight needed to attract more clientele. Additionally, IPOs provide companies with a layer of hard earned credibility owing to the fact that they need to successfully endure a lot of scrutiny and report their facts correctly.

Reduced Overall Cost of Capital – What plagues several companies but especially young companies is the cost of capital. Prior to going public companies are often subject to paying higher interest rates to receive loans from banks. With an IPO, availing additional capital is far easier. This is owed in part to the fact that the company is audited heavily which showcases their credibility. Lenders are then more amenable to extending lines of credit at more lucrative interest rates.

Stock as a Means of Payment – While stock of a private company holds value only provided favourable exit opportunities arise, public company stock can be viewed as a kind of currency that can be bought and sold at any point in time keeping in mind the market price.

Listing IPO Disadvantages

Additional Regulatory Requirements and Disclosures – While private companies are spared, public companies are required to disclose their financial statements to the Securities and Exchange Board of India each year. The process of disclosure in itself in terms of preparing the statements and auditing them is expensive.

Market Pressures – Said pressures can adversely impact company leaders that are used to operating in accordance to what works best for the company. The stock market has a short-term approach with profits being key whereas founders focus on the long term and the impact the company will have on the world. These two approaches can be in opposition to one another leading to issues.

Potential Loss of Control – IPOs can reduce the control the founders of a company may have on their company. Although said founders can retain a majority of the decision-making power in their company, keeping the public happy becomes paramount once a company is public. Shareholder votes and public criticism can force leadership to be changed.

Transaction Costs – The costs associated with initial public offerings are expensive. Apart from frequent expenses associated with ensuring public companies comply with regulatory rules, IPOs incur tons of other expenses. Underwriters fees are known to be the most pronounced following legal fees, auditor fees, registration and printing.

Conclusion

Now that you have examined the advantages and shortfalls of initial public offerings, consider visiting Angel One’s Smart Money portal so that you can learn more about recent IPOs.

Frequently Asked Questions

Q1. What does IPO stand for?
A1. IPO is the acronym used to refer to an initial public offering.

Q2. What is the biggest expense associated with an IPO apart from complying with public company regulatory norms?
A2. Underwriter fees are exceptionally expensive and known to be one of the biggest expenses associated with IPOs.

Q3. Who can potentially lose control with an IPO?
A3. With an IPO, a company goes public and while the founders / original leadership of said company may enlist means via which they retain majority decision making control, original leaderships seek to lose control of their company.

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