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IPO Explained for Beginners

IPOs explained

October 22, 2020 | 

JOHN K MWANIKI |  0 Comments| 

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An Initial Public Offering (IPO) is the means for a private company to become public. The company sells its shares on a stock exchange following a rigorous process. The process involves working with an investment bank for due diligence and compliance.

Here is all you need to know about IPOs

The IPO Process

The IPO is a long process that lasts anywhere from six months to over a year for completion. Here is the step by step IPO process for companies; 

  • Select a bank 

The first step starts six months before the IPO. The company selects a bank which will conduct the process. 
It's the bank's responsibility to reach potential investors. They can consider other banks, institutional investors, or public investors

The company and the bank signs an underwriting. It is the document detailing the amount to be raised, type of securities, and fees. The bank charges around 3% - 7% of the total IPO sale price.

  • Due diligence and filings 

The second step involves identifying the company's regulatory compliance. It happens three months before the IPO. 

The process involves lawyers, accountants, and other experts. They help determine the real state of the company. The team comes up with ways to improve money flow and assess the management.

This is also the point to inform the SEC of the intention to hold an IPO. The commission investigates the company to ascertain the given information.

  • Pricing 

Once the SEC establishes the validity of information, they help guide on the IPO date. Before then, the company comes up with the share prices. The pricing depends on the value of the company. Still, the success of roadshows and economic status also matters.

After this is when the company joins the stock exchange listing its shares. Investors also make biddings at this point. 

  • Stabilization 

This is the period after the IPO, where the stocks must stay active. It lasts for 25 days as the underwriter still offers the shares.

  • Transition

This is where the company becomes a public entity. The underwriter ascertains the sold shares and advises the company on transition. Shareholders are also free to sell at this point.

Advantages of IPO 

IPO has been one of the most popular ways to raise funds due to the several benefits. It allows access to investment from the public when raising funds. This is a vast opportunity compared to private investors.

An IPO comes with several regulations. The company fulfills several requirements before they can go for the public offering. They must have updated records and also show the possibility of growth. These standards help improve investor confidence. It also shows the success of a company hence ease of attracting funders.

The IPO also supports the company for other sources of income. The company can go for secondary offerings after an earlier successful IPO. 

Public companies can use IPOs to attract and keep talents. They can offer the employees liquid stock equity participation in the company. 

The company compensates employees with stocks during the IPO. This is attractive for most people due to the controlling stakes. 

Still, an IPO is excellent for the company's profile. It bolsters the companies' prestige and public image. The new-found status helps in improving sales.

Disadvantages of IPO 

Even with the several advantages, IPOs come with some shortcomings. The first concern is that it is quite expensive. There are several costs unrelated to IPO that affects the whole process. The compliance audits and other regulations are quite costly.

The IPO period calls for the company to be open to public scrutiny. The company discloses financial and tax records and other crucial business information. While these are great for investor confidence, they put the business at risk. Competitors can use the information for countering development.

The IPO, while great for funding, is not ideal when looking to retain control of the company. The new shareholders gain controlling stakes from the shares. They can overrule management through the board of directors. Poor governance by the board can even lead to the loss of some management.  

The whole IPO process is stressful. The company reserves the time and effort to ensure correct reporting and compliance. All these for a process that also risks failure in case of price rejection by the investors.

The IPO also increases the companies risks of legal and regulatory concerns. There is the possibility of shareholder actions and securities class action. 

Alternative to IPO 

Even though IPOs are successful, not all companies are willing to risk the concerns. They want a less stressful means of getting funds while also retaining control. One of the most viable IPO alternatives is the Initial Coin Offering (ICO)

ICO is a decentralized means of raising capital for a project. It differs from IPO such that it is offered in the early stages of a project. The company does not have to show any proof of existence. They only provide a whitepaper detailing the future and components of the project. 

The decentralization of ICO also means fewer regulations. The Securities and Exchange Commission regulates IPOs. Unlike ICOs, which are self-regulated on the blockchains. Even though the lack of regulation would make it seem risky, it is still secure. It provides for autonomously executed programs devoid of human interference.  

ICO also comes with better reach than IPO. ICOs mostly involve digital currencies. A trader only needs internet access to get the shares. 

IPO, however, is country-specific. Investing in foreign IPOs require brokers, which is costly. 

Still, ICOs come with some concerns. The lack of records and regulations opens it up for scams. The traders have to ensure due diligence before investing.

Bottom Line 

An IPO is one of the most reliable ways companies raise funding. It is also how private companies become public. It is reliable due to the high regulations. The popularity of IPO makes it easy to market hence attract more funding.

It, however, also comes with a few concerns like prolonged processes. It is also meant mostly for local investors, which is limiting. The problems give way to the option of ICO.

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