Why Invest in an IPO and its Benefits?
Initial Public Offering (IPO) has long been one of the ways companies raise funds from the general public, but recently, many IPOs have been receiving extraordinary interest from investors. The rising popularity of IPOs is due to the various benefits they offer to investors.
In this blog, we will explore the reasons why companies launch an IPO and the various benefits of investing in an IPO.
What is an IPO?
A firm that intends to be listed as a public company must first raise money via an IPO or initial public offering. The funds raised can be used for growth, repayment of debts, acquisition, etc. There are also situations when shares offered in an IPO are sold by the early-stage investors or the firm’s promoters. After the IPO, the shares of the company are listed on the stock exchange and can be traded.
Why Do Companies Offer IPO?
Companies choose initial public offerings (IPOs) for the following reasons:
1. To raise capital: Businesses typically seek to raise funds for business expansion since they can use the funds to expand their operations.
2. Debt Repayment: With the money raised, the company may pay off its current debt and improve its debt ratios, making this another reason for raising capital.
3. New Opportunities: Businesses can use the funds to establish operations in overseas markets by exporting their goods and services.
4. Research: Companies can use the money raised from the initial public offerings (IPOs) to improve the quality of their goods and services by developing new technologies.
5. Liquidity for Current Investors: Founders, venture capitalists, and early investors occasionally sell their ownership stake through an initial public offering (IPO) process and look for other investment opportunities.
6. Acquisitions: Funds raised in an IPO can be used by the company to acquire other businesses.
7. Increase in Popularity: A successful initial public offering (IPO) increases the popularity of the company among investors and its customers, which can result in higher sales and profits.
Why Should You Consider Investing in an IPO?
The primary reasons to consider investing in an IPO are as follows-
- Listing Gains – In an IPO, if the shares trade at a price higher than the offer price on the listing date, then the investors can sell their shares and realize substantial listing gains.
- Investment Opportunity – An IPO offers individuals a chance to invest in companies in their early stages.
- Portfolio Diversification — If the company is operating in a different sector than the ones you are currently invested in, individuals can invest in IPOs of such companies and minimize their overall portfolio risk.
- Potential Long-Term Growth — Companies with strong historical performance tend to have longer-term growth potential. Investors can judge the past performance of the company by using the data provided in the Red Herring Prospectus (RHP).
- Lower Pricing – Some initial public offerings (IPOs) are intentionally issued at a lower price to attract more investors, making them an excellent investing opportunity for traders or investors.
- Transparency – The annual reports and other documents of companies launching an IPO are subject to strict regulations, which makes them more transparent.
- Liquidity – Once a firm makes its shares public, its shares can be easily bought and sold on the stock exchange.
Benefits of Investing in IPO
The major benefits of investing in an IPO are as follows:
1. Immediate Gains: If the company opens at a price higher than the offer price, investors can choose to exit by selling the shares received and realizing substantial listing gains. There were several instances in the recent past when the shares offered in an IPO increased substantially as the investors who didn’t get the allocation tried to purchase it on the listing date.
2. Flexibility: Investors can purchase and sell shares at any time without incurring high transaction costs in the stock market, as the company is publicly listed.
3. Fair Opportunity: SEBI has several regulations in place to ensure that small investors have an equal opportunity to receive shares in an initial public offering (IPO). In case of an oversubscribed issue, a lottery system is used to allot IPO shares to the general public. However, if the IPO is not fully subscribed, each IPO applicant receives the number of shares they have applied for.
4. Compliances: SEBI has established strict regulations for companies launching an IPO to safeguard individual investors. To allow investors to make an informed choice, the company’s prospectus must include all necessary information, such as performance, financials, growth, risks, and plans.
5. Purchase at a Discount: Companies can choose to offer their shares at a reduced price when they go public to attract more investors. Due to the initial low price, the shares typically list at a premium, which creates a positive image of the company and results in listing day gains for the investors.
6. Ownership: Investors who are allotted shares in an IPO are regarded as shareholders of the business and can cast their votes at the annual general meetings.
7. Early Stage Opportunity: An initial public offering (IPO) allows investors to purchase stock of a company during its early stages. Some of these companies can become a major success in the future and deliver multi-bagger returns to their investors.
8. Consistent Income: Several companies distribute dividends to their shareholders. Therefore, investing in these dividend-paying businesses allows you to generate a steady income.
Conclusion
On a concluding note, you may be considering investing in an IPO the next time an opportunity comes across by reading the advantages mentioned above. However, keep in mind that an IPO’s performance solely depends on the subscription data of a particular IPO. Market sentiment on the listing date and several other factors also affect listing gains. To make an informed investment decision, one must conduct a thorough financial analysis, which includes evaluating the company’s historical performance, growth prospects, and reasons for raising funds. Before making any investing decisions, you, as an investor, must speak with your investment advisor.
Frequently Asked Questions (FAQs)
Why does the company launch an IPO?
A corporation launches an initial public offering (IPO) to raise funds, which it might utilize for debt repayment, business expansion, and other purposes.
Is an IPO a good option for short-term or long-term investments?
Shares allotted in an IPO can be kept for the long term as well as the short term, depending on the future growth prospects of the company. The holding period also depends on the investor’s goal; some may seek listing gains, while others hold it for long-term potential growth.
Can I apply for an IPO without a Demat Account?
Investors cannot apply for an IPO if they do not have a Demat account.
How are the IPO’s issue prices determined?
In a fixed price issue, the company’s underwriter sets the price at which the investors can purchase shares. In a book-building issue, the company announces a price range, and the investor bids within that range to determine the issue price.
Is it right to invest in every Initial Public Offering (IPO)?
No, it is not wise to participate in every initial public offering (IPO) since there may be instances where the company may be aggressively priced, and the IPO’s issue price may be too high. Instead, it is advised to research the company’s fundamentals before investing.
