Initial Public Offering

Initial Public Offering Ayush Parab - TYBA Economics Indian Financial System (ECOIFSA603) 08/01/2022 Mobile No – 9022125295

Introduction In many economies, the initial public offering has been employed in the privatization of state- owned firms, particularly those of strategic importance to the government. This further influenced private-sector enterprises to take this move, allowing them to earn additional funds to fund their future expansion. Based on the previous experience of many developed countries and countries in the region, privatization through the public offering of shares has significantly contributed to the development of these countries' capital markets, which is primarily reflected in the growth of market capitalization, the volume of turnover, number of transactions, and participation of local and foreign investors. The process of issuing shares of a private firm to the public in a fresh stock issuance is known as an initial public offering (IPO). An initial public offering (IPO) allows a firm to raise funds from the general public. The move from a private to a public firm, which often involves a share premium for current private investors, can be a crucial opportunity for private investors to completely realize rewards from their investment. Meanwhile, public investors are allowed to participate in the offering. A corporation is deemed private before it goes public. The firm has expanded with a limited number of stockholders as a pre-IPO private company, comprising early investors such as the founders, family, and friends, as well as professional investors such as venture capitalists and angel investors. An initial public offering (IPO) is a significant milestone for a company since it allows it to raise significant funds. This increases the company's capacity to expand and grow. The enhanced transparency and legitimacy of its stock listing may also help the company acquire better terms when seeking borrowed capital. But not every IPO has to give you massive returns; sometimes, even when the company fundamentals aren't that good, some companies ride a wave of bull runs and debut their shares through successful IPOs. New age investors don't look too deeply into the company analysis

side of things before investing in an IPO and instead rely on word of mouth and other investors' recommendations. This is a poor investment technique that can result in negative investments. When investing in a company, there are many things to examine, such as the firm's fundamentals, balance sheet, return on equity ratio, profitability, prospects, and so on. All of these criteria go into determining whether or not investing in a company is a good idea. Most investors participate in IPOs for the purpose of profiting on the first day of trading, but a popular firm may list at a premium, lose momentum, and then fall in price, taking a long time to recover. Zomato is an example of a firm that first floated at a 70 percent premium and later fell due to poor company fundamentals and the fact that it is a loss-making business. In another case, despite being substantially subscribed during the IPO period, a well-known company can list with significant discounts in the stock exchange market. Paytm, for example, set a pricing band of roughly 2200rs before listing at a 40% discount and making a low of 1220rs in the market within two days after listing. So it's not a good idea to invest blindly in all IPOs just because users think they'll make money on the first day of trading. To invest in a company and prevent losing money in the process, a thorough analysis and financial understanding of the company is essentials. Assumptions • Capital Market is in stable condition, without any extraordinary fluctuations Hypothesis • Mismanagement and a lack of planning cause companies to fail to sustain long-term growth despite listing success.

Variables • Capital Markets • Initial Public Offering • Company Fundamentals Learning Objectives • To Study how a Company becomes public through an Initial Public Offering • To analyse how company fundamentals play an important part for the sustenance of the company over a period of time Analysis on Assumption and Hypothesis For a stock to move normally, the market must be steady; if the capital market is influenced by abnormal fluctuations or unexpected news, stock behaviour is abnormal, and stock prices are primarily influenced by that cause. In such instances, releasing an IPO is not ideal since the price of the IPO shares at the time of debut during an abnormal market would not reflect the stock's true real potential to perform based on its fundamentals, but rather will be a news-driven price volatility. Some companies hunt for opportunities in the capital market to launch their initial public offering (IPO) by riding the IPO hype wave. This is a condition in which companies tend to price their initial public offerings higher than their true prices. Retail investors are duped in this case, and they lose a lot of money while the corporation profits handsomely from the Wave.

What is an IPO An initial public offering (IPO) is a type of stock that is sold to the general public. An initial public offering (IPO) is when a privately held firm lists its stock on a stock market and makes it accessible for purchase by the general public. Many people think of initial public offerings (IPOs) as massive money-making opportunities— when high-profile companies go public, their stock prices skyrocket. While they're unquestionably fashionable, you should be aware that initial public offerings (IPOs) are extremely risky investments with variable long-term returns. Although an initial public offering (IPO) is the first time the general public can acquire shares in a company, it's crucial to remember that one of the aims of an IPO is to allow early investors in the company to cash out their assets. Consider an IPO to represent the conclusion of one stage in a company's life cycle and the commencement of another—many of the initial investors want to cash out on a new venture or start-up. Investors in more established private companies that are going public, on the other hand, may prefer the option to sell some or all of their shares. Other reasons for a corporation to pursue an IPO include obtaining finance and increasing its public profile: • Companies can raise money by selling stock to the general public. The money might be used to grow the company, fund research and development, or pay off debt. • Other capital-raising options, such as venture capitalists, private investors, or bank loans, could be too expensive. • Going public via an initial public offering (IPO) can give a company a lot of exposure. • Companies may desire the status and gravity that comes with being a publicly traded company, which may help them achieve better lending terms. While becoming public may make it easier or less expensive for a company to raise funds, it also complicates a number of other issues. There are standards for disclosure, such as filing quarterly and annual financial reports. They must answer to shareholders, and there are

reporting requirements for stock trading by senior executives and other actions such as asset sales or acquisitions. Working of an IPO Going public is a complex, time-consuming process that most businesses find difficult to navigate on their own. A private firm seeking an IPO must not only prepare for a massive increase in public scrutiny but also file a mountain of paperwork and financial reports to satisfy the Securities and Exchange Board of India (SEBI), which regulates public corporations. That's why a private firm planning to go public engages an underwriter, usually an investment bank, to advise them on the IPO and assist them in setting an initial price. Underwriters assist management in preparing for an IPO by generating important investor documents and conducting roadshows with potential investors. The underwriter issues shares to investors and the business's stock begins trading on a public stock exchange, such as the National Stock Exchange (NSE) or the Bombay Stock Exchange (BSE), once the company and its advisors have chosen an initial price for the IPO.

Types of IPOs Fixed Price Offering Book Building Offering • The issue price that some companies • In the case of book building, the firm set for the initial selling of their launching an IPO provides investors shares is known as a fixed price IPO. a 20% price band on the equities. The price of the stocks that the Before the final price is set, interested corporation decides to make public is investors place bids on the shares. revealed to the investors. Investors must define the quantity of shares they wish to purchase as well • Once the offering is concluded, the as the price per share they are ready market demand for the stocks can be to pay. determined. If investors participate in this IPO, they must pay the entire • The floor price is the lowest stock price of the shares at the time of price, while the cap price is the application. maximum stock price. The final decision on the price of the shares is made by the bids of investors.

Process of an IPO The company contracts an underwriter, usually a consortium of investment banks which A private company decides to raise capital assess the company's financial needs and through an IPO. decide the price/price band of shares, number of shares to be offered etc. The underwriter then participates in the SEBI carefully scrutinises the application and drafting of the application (to SEBI) for after making sure that all eligibility norms are approval with details of the company's past fulfilled, it gives the company the go ahead to release the ‘red herring prospectus’. The ‘red financial records including profits, herring’ prospectus is a document released by debts/liabilities, assets and net worth. Also, the company mentioning the number of shares the draft mentions how the funds to be raised and the issue price/price band (price of one will be used. share) to be offered in the IPO. It also has details of the company's past performance. In what is called a ‘Road show’, executives An IPO opens and can last for 3-21 days, travel to meet with and woo potential though it is usually open for 5 days.During this investors to buy their company’s shares. time, retail investors can bid for stocks through their banks/brokerages via the Internet. Investors need to have a demat account to participate in an IPO, and a PAN card.If the stocks you bid for are allotted, they'll be credited to your demat account. If not, you'll get your money back.

Why Do Companies Go Public ➢ To raise Capital for growth and Expansion Every business requires funds to expand operations, develop new goods, or pay off existing debts. Going public is a terrific way for a firm to raise much-needed financing. ➢ Allowing owners and early investors to sell their stake to make money It's also considered as a way for early investors and venture capitalists to cash out. An initial public offering (IPO) allows a firm to become more liquid. At this point, venture capitalists sell their stock in the company in order to profit and exit. ➢ Greater Public Awareness In the stock market calendar, IPOs are indicated with a star. These events have generated a lot of interest and publicity. This is an excellent way for a business to introduce its products and services to a new group of clients.

Eligibility norms for companies planning to file an IPO as stipulated by SEBI The company should have had net tangible The company should have had an operating assets (defined as physical assets plus profit of minimum 15 crores for at least three monetary assets of at least 3 crore rupees in years in the preceding five years. each of the last three years. Doesn’t include virtual assets with fluctuating value like shares) The size of the IPO can't exceed the company's Even if these criteria are not fulfilled, the worth by more than five times. company can still file a request for approval of an IPO with SEBI. But, for such approvals, the IPO can only take the book building route where 75% of the stock has to be sold to Qualified Institutional investors (QII). This has to be done for the sale of stocks under the IPO to be held as valid. Otherwise, the IPO is cancelled and the capital raised has to be returned. SEBI functions to protect the interests of investors while ensuring that norms aren't too stringent to dissuade prospective companies that have the potential and the vision to deliver growth. Key Terminologies Associated with an IPO ➢ Issuer The company or firm that intends to issue shares in the secondary market to fund its operations is referred to as an issuer. ➢ Common Stock Units of stock in a public business that normally permit holders to vote on corporate decisions and receive dividends from the company. When a firm goes public, it sells shares of common stock.

➢ Underwriter A banker, financial institution, merchant banker, or broker can all be underwriters. It aids in the underwriting of the company's stock. In the event that investors do not choose the stocks offered at the IPO, the underwriters promise to subscribe to the remaining shares. ➢ Lot Size In an IPO, the smallest quantity of shares for which you can place a bid. You must bid in multiples of the lot size if you want to buy more shares. ➢ Fixed Price and Price Bands The issue price that some companies set for the initial selling of their shares is known as a fixed price IPO. A price band is a way of determining value in which a seller sets an upper and lower cost limit, within which prospective buyers can submit their bids. The purchasers are guided by the price band's range. ➢ Undersubscription and Oversubscription When the quantity of securities applied for is less than the number of shares made available to the general public, this is known as under subscription. When the number of shares issued to the public is less than the number of shares applied for, this is known as oversubscription. ➢ Green Shoe Option It's a type of overallotment option. It's a type of underwriting agreement that allows the underwriter to sell more shares than the firm had expected. It occurs when the demand for a certain stock is larger than projected. In the event of oversubscription, it allows the issuer business to sell extra shares on the secondary market. ➢ Book Building Book building is the process by which an underwriter or merchant banker attempts to identify the price at which the IPO will be launched. The underwriter creates a book in which he presents institutional investors' and fund managers' bids for the number of shares and price they are willing to pay. The underwriter or merchant banker determines the IPO price once an idea has been developed and a price band has been established. The shares of the issuer firm are available for subscription for three trading days.

➢ Draft Red Herring Propectus The DRHP is a document that informs the public about a company's IPO listing once SEBI has approved it. A DRHP contains the following information about the company: Purpose of raising funds through listings Balance sheet Promoter’s expenses Earning statement of the last three years (if applicable) Net proceeds of the company Commission and discounts of the underwriter Details such as the name and address of all the underwriters, officers, directors, and stockholder who possess 10% or more than the currently outstanding stock. Legal opinion on the listings Copy of the underwriting document

Different investor categoriesHow are shares allocated in an IPO? Non Institutional Investors (NIIs) Qualified Insititutional Buyers (QIBs) Retail Individual Investors (RIIs) In an IPO, the allocation of shares differs for each of the above groups. You fall into the last category as an individual investor. You can invest in small lots for Rs 10,000-15,000 as an individual investor. In an IPO, you can apply for a maximum of Rs 2 lakh. The number of applications received in the retail sector is used to determine the total demand for shares. You will be offered a full allotment of shares if demand is less than or equal to the number of shares available in the retail category. In such circumstances, investors are offered shares in the retail sector by a lottery. This is a computerised method that assures that investors are allocated shares fairly. Oversubscription occurs when the demand exceeds the available supply. An initial public offering (IPO) can frequently be oversubscribed five times over. This suggests that the demand for shares is five times greater than the supply! In such circumstances, investors are offered shares in the retail sector by a lottery. This is a computerised method that assures that investors are allocated shares fairly.

Advantages of Listing the Company on Public Exchange ❖ Fundraising Money is the most frequently mentioned benefit of an initial public offering. The overall proceeds from an initial public offering (IPO) in 2021 were $500 billion, with numerous IPOs raising hundreds of millions of dollars. The biggest IPO in 2021, for example, was PAYTM, which raised Rs 18,300 crore. Even without considering the other benefits, the proceeds from an IPO provide adequate motivation for many companies to go public, especially given the numerous investment options available as a result of the extra capital. These money can help a growing business in a variety of ways. An initial public offering can be used to fund research and development, hire new personnel, build facilities, decrease debt, fund capital expenditure, acquire new technologies or other companies, or a variety of other things. An IPO provides a large sum of money that can drastically alter a company's growth trajectory. ❖ Exit Opportunity Stakeholders in any firm have invested substantial time, money, and resources in the hopes of building a successful business. For years, these founders and investors may not see a meaningful financial return on their investments. An initial public offering (IPO) provides investors with a huge exit option, allowing them to possibly obtain large sums of money or, at the at least, liquefy the cash they have invested in the company. As noted in the above paragraph, initial public offerings (IPOs) frequently raise approximately Rs 1000 crores (or even more), making them very appealing to founders and investors who believe it is time to be compensated financially for years of \"sweat equity.\" It's worth noting, though, that in order for founders and investors to get cash from an IPO, they'll have to sell their shares in the now-public firm on a secondary market (e.g., NSE, BSE). The proceeds of an IPO do not provide liquidity to shareholders right away. ❖ Publicity and Credibility An IPO can provide this exposure by thrusting a firm into the public spotlight. If a company intends to continue to grow, it will require increasing exposure to potential customers who are familiar with and trust its products. Every initial public offering is covered by analysts all around the world in order to help their clients decide whether or not to invest, and numerous news organisations cover different firms that are going public. When a company decides to go public, it receives not just a lot of attention, but

also a lot of credibility. To complete an offering, a company must undergo rigorous inspection to ensure that the information they are disclosing about themselves is accurate. This examination, combined with the fact that many people trust public corporations more, can boost a company's and its goods' credibility. ❖ Reduced Overall Cost of Capital The cost of financing is a key barrier for any company, but notably for smaller private companies. Companies must typically pay higher interest rates or give up ownership in order to collect funding from investors prior to an IPO. An IPO can greatly reduce the difficulties of obtaining new financing. A corporation must be audited according to criteria before it can begin the formal IPO preparation process. This audit is typically more thorough than previous audits, providing greater assurance that the information provided by a corporation is accurate. Because the organisation is viewed as less risky, this enhanced confidence will likely result in lower interest rates on bank loans. Aside from cheaper borrowing rates, after a firm becomes public, it can raise more money through successive stock market offerings, which is usually easier than raising money through a private investment round. ❖ Stock As Means of Payment Being a publicly traded company also allows you to pay with publicly traded stock. While a private firm can use its shares to make payments, private stock is only valuable if there is a good exit opportunity. Public stock, on the other hand, is a sort of cash that can be purchased and sold at any time at a market price, which can be useful when rewarding staff and acquiring other firms. In order for a business to succeed, it must hire the appropriate people. When it comes to hiring top-tier talent, the flexibility to pay employees in stock or provide stock options helps a company to compete even if the base monetary compensation is lower than what competitors are giving. Furthermore, acquisitions are frequently a crucial strategy for businesses to continue to expand and remain relevant. Purchasing other businesses, on the other hand, is usually highly costly. When a company goes public, it can issue shares of its stock instead of spending millions of rupees in cash as a form of payment.

Disadvantages Of Listing The Company On Public Exchange ❖ Additional Regulatory Requirements And Disclosures Public firms, unlike private companies, are required to file annual financial statements with the Securities and Exchange Commission (SEC) like SEBI in India . These financial statements must be prepared in accordance with Generally Accepted Accounting Principles used in India and must be audited by a registered public accounting firm. These SEC standards are both time consuming and expensive. Establishing more stricter financial controls, staffing a financial reporting team and audit committee, implementing quarterly and yearly financial closure processes, hiring an audit firm, and hundreds of additional duties are all required when a company's financial situation is publicly reported. Every year, these responsibilities cost public firms millions of dollars and thousands of hours of effort. See our article Audit Preparation for the Big Leagues for more information on public company audits. ❖ Market Pressures For company leaders who are accustomed to doing what they believe is best for the organisation, market pressures can be extremely challenging. Founders often have a long-term view of their firm, seeing what it will look like years from now and how it will effect the world. The stock market, on the other hand, has a profit-driven, short- term perspective. When a company goes public, every move it makes is analysed by investors and analysts all over the world, who are mostly concerned with one question: \"Will this company fulfil its quarterly earnings target?\" If a corporation achieves its goal, its stock price will often rise; if it does not, it will typically fall. Even if leadership is acting in the long-term best interests of the company, failing to achieve the public's short-term goals may cause the company to lose value, and leadership may be removed as a result. Founders who dislike the idea of being restricted by short-term public aims may consider going public with caution. ❖ Potential Loss of Control One of the most significant disadvantages of an IPO is that founders may lose ownership of their business. While there are ways to ensure that the business's founders retain the bulk of decision-making power, once a company becomes public, the leadership must satisfy the public, even if other shareholders do not have voting power. Going public entails getting significant funds from public shareholders. Because shareholders have invested so much in the company, they expect it to operate in their

best interests, even if that means going in a path that the founders don't like. If shareholders believe the firm is not running in a way that will help them gain money, they can push the corporation to choose new leadership through shareholder votes or public criticism. How Do Investors Benefit because of IPO ❖ First Mover Advantage This is especially true when well-known corporations launch an initial public offering. You have the opportunity to purchase the company's stock for a significantly reduced price. This is due to the fact that once the company's shares reach the secondary market, their value may skyrocket. ❖ High Returns Buying shares in an IPO might be beneficial if the company has the potential to grow. The company's strong fundamentals indicate that it has a decent probability of expanding. This could be beneficial to you as well. You have a decent possibility of making money in the long run. ❖ Listing Gains A company's stock may be traded at a price that is higher or lower than the allotment price when it is listed on the stock exchange. Listing gains occur when the starting price is higher than the allotted price. Due to variables such as market demand and optimistic bias, investors often expect an IPO to do well when it is listed. This, however, does not always occur. It's also feasible that a stock's price will fall by the end of the first trading day. In actuality, listing profits may not produce positive long-term returns for the investor. So, if you're a trader looking for quick profits, it can be a good fit. Long-term investors, on the other hand, should look for a company that can provide substantial profits in five or even ten years.

Why some Companies fail to sustain the IPO listing gains in the Long Term For the past 1.5 years, India's stock market has been on a tear, with the Sensex reaching over 60k and the Nifty exceeding 18k on many occasions. Companies are not squandering any opportunity to enter the market, thanks to the bull market's favourable enthusiasm. Only in 2021 has Dalal Street seen about 46 IPOs, with Paytm triumphing over Coal India to become India's largest IPO in almost a decade with an issue amount of Rs 18,300 crore. However, investors were disappointed on Thursday as the digital fintech startup made a shaky market debut, with its stock plummeting 20%. Underperformance of IPOs is widely considered as a sign of long-term market performance, but it is not as common as IPO underpricing in the short term. Long-run underperformance occurs when succeeding share prices are lower than those of the first trading day, resulting in negative abnormal returns for investors over time. The inconsistent results and challenging findings gained by financial academics suggest that long-run market performance is a contentious issue. According to several studies, initial public offerings (IPOs) underperform marginally or have no aberrant long-term performance. When the anticipation surrounding a new business or product fails to live up to the hype, interest soon fades. Even if an initial public offering (IPO) has a great start, it can lose money on the first day of trading or in the days following. According to Goldman Sachs, just around a quarter of companies going public in 2019 will have a positive net income, the lowest ratio since the Information Age began. Uber and Lyft haven't fared well since their first public offerings, but Goldman Sachs pointed to biotech businesses as lowering the average. Biotech companies make up 28% of all IPOs, and they aren't expected to be profitable for the next three years. When a stock is in high demand, investment banks rush to sell all available shares at the first public offering. Once potential purchasers have acquired their shares, there is usually little interest in the stock once it begins trading. The greatest technique is for investment banks to

sell shares strongly while leaving a cadre of investors available who couldn't get shares on the initial public offering. The function of the underwriter is to measure the demand in the market, ensure that they're pricing it effectively, and be on the lookout for investors that might be tempted to dump their shares in short order. Some investors are eager to sell stock while it's hot, execute a quick flip and make a fast profit. Large institutions have much less loyalty. If a new stock isn't performing, the corporation may sell it early so they can maintain the remainder of their portfolio robust. This may be in their best interests if a stock doesn't look like it will be successful in the coming years. There are two reasons why there are so many IPOs on the market right now. One is that, following the pandemic, we experienced a recovery in various industries. Export-oriented sectors including IT, healthcare, chemicals and metals are seeing a demand recovery. All of these businesses are experiencing significant export demand. The second factor is that as the Indian economy improves, confidence in the system has begun to return. When the market is on the rise, promoters often want to go public because investor sentiment is favourable. After 6 months or a year, 60-70 percent of all IPOs underperform the market, so it's crucial to keep an eye on how they perform after they've been listed. As a result, not all IPOs will be successful. It's similar to picking a stock. Investors should consider values, business fundamentals, and the sector in which the company operates. You'd do the same thing with any other stock. Do not be fooled into believing that all initial public offerings (IPOs) will succeed; in reality, this is not the case. Below is the list of some big IPOs which hit the market and failed to sustain the momentum and were trading at discount -

Company Name List Date Issue Price Listing Price Change Post Lisitng Coal India 4th November 2010 245 288 -40.3 Yes Bank 27th July 2020 12 12 6.5 GIC RE 25th October 2017 912 425 -67.5 SBI Cards 16th March 2020 755 658 67.7 New India 13th November 2017 800 375 -57.9 Assurance Relaince Power LTD 11th February 2008 450 372.50 - ICICI Prudential 29th December 2006 334 329 99.2 ICICI Lombard 27th September 2017 661 650 132.4 These numbers show that market sentiment can shift in any direction, regardless of whether the IPO is for a large-cap or a small-cap company. Since 2008, 100 out of 164 initial public offerings (IPOs) have traded below their issue price, according to statistics from the Economic Times. Only 44 firms have given double-digit gains among the remaining equities that have given good returns. During this time, the benchmark Sensex, on the other hand, has more than doubled. Meanwhile, many analysts believe that some IPOs fail because they were overpriced, despite the fact that stock performance is also influenced by other factors such as industry forecast, business quality, and management.

Conclusion The basic result is that, despite their higher risk, IPO returns have been dismal unless you're well connected enough to secure an allocation at the IPO price (as the average IPO returns 12 percent on the first day). If a company's fundamental conditions aren't up to par, it won't be able to maintain its listing momentum after launching an IPO. Such a corporation experiences a stock price correction and loses value over time.

Limitations ❖ Due to the present situation, primary data gathering was not possible, ❖ secondary data sources were inaccurate and limited. ❖ A lot of data was only provided in written form, with no illustrations or graphs to aid comprehension. Benefits from selecting this topic ❖ Getting a thorough understanding of Initial Public Offerings and how the entire process works in practise ❖ Assisted in comprehending how company financials play a key role in capital market company valuation. ❖ Learning about the market's most recent IPOs, how corporations ride the IPO wave, and what IPO frenzy is, among other things.

References ❖ https://www.cbsnews.com/news/why-ipos-underperform/ ❖ https://groww.in/p/what-is-ipo/ ❖ http://www.maco.jfn.ac.lk/ijabf/wpcontent/uploads/2017/11/Vol2_Issue1_1.pdf ❖ https://www.diligent.com/insights/ipo/what-happens-when-your-ipo-fails/ ❖ https://www.financialexpress.com/money/initial-public-offering-7-things-to- understand-before-investing-in-an-ipo/2294677/