Initial Public Offering Definition IPO. The first sale of stock by a company to the public.

The most common reason for a company to initiate an IPO is in order to raise more capital. One of the most difficult parts of an IPO is to determine the proper price to initially offer the new stock; too high and investors won't be interested, but too low and the company is sacrificing the amount of money that might have been made if they priced it higher. There is generally a significant amount of risk in an IPO, because the company going public is frequently small or relatively unknown, and hasn't had a chance to prove itself to the public; as such, they also have the capacity for significant payoffs. Some general steps in the IPO process for a company may be: 1. Company plans for the IPO process. o Makes sure company financial records are consistent. Business visions and goals are clearly spelt out. o Picks team to handle the IPO process. The team has: 1. Lead manager - the Lead Manager is usually an independent financial institution or investment bank. The Lead Manager helps manage the IPO process. Also known as the Lead underwriter. 2. Registrar of Issue - (the Indian IPO process requires this) - the Registrar handles the IPO share allocations. 3. Syndicate - syndicate refers to a group of financial institutions which purchase the IPO shares to sell it to the general public. o Plans timetable for going public

2. Company prepares draft prospectus of the company and the IPO and

files it with the regulatory authorities. - The prospectus plays a very important role in the IPO process, that of convincing the general public and other institutional investors to put their money in the IPO. It must also be validated and approved by regulatory authorities, that is the Securities Exchange Commission (SEC) in the United States and Securities and Exchange Board of India (SEBI) in India. The IPO prospectus may contain information such as o Historical financial data of the company o Company products and services, with business goals o Management information 3. Roads Shows for the IPO are held where company officials meet potential institutional investors and publicise the IPO.

4. Lead Manager submits the approved prospectus to stock exchanges where the issuing company wants to register, and decides the issuing price of shares to be offered to the general public. The offer prospectus is modified and the issuing price of shares is inserted into the prospectus as well as the date of issue. 5. The IPO application forms and prospectus is given to syndicate members who distribute it to the general public. 6. The IPO subscription for investors begins. Syndicate members keep giving information about the IPO subscription to the stock exchanges. 7. After a specific number of days, the IPO is declared as final and closed. 8. The final issue price is updated by the Lead Manager and sent to the stock exchanges. 9. Shares are allotted to the investors. 10. The new public company is listed on the stock exchange.

How is the price discovered during IPOs? The issuer companies have two options for fixing the price. They can either fix the price themselves or they can let the investors determine it. The first method, in which the company itself fixes the price, is known as the fixed-price method and the second, in which investors determine the price, is known as the book-building method. It is important to keep in mind that even in the fixed-price method, the prices are not determined randomly and the company has to disclose all the quantitative and qualitative factors that justify the fixed price. But the fixed-price method has one drawback. It does not take into account investor demand . If you want to sell a piece of gold at its intrinsic value but there is no demand in the market, your piece of gold will not be able to fetch that price. Fixed-price issues also face a similar problem. The issuers arrive at the fixed price after taking into consideration the reasonable value of their company but if there is no demand in the market, the shares will fail to generate subscription. In the opposite scenario, if the demand in the market is high, the price fixed by the issuer may not reflect the true market value and the shares may get sold at a

low price. To overcome these kinds of problems, issuers use the bookbuilding method. It helps in matching the price of shares with the demand. How does the book-building method work? In the book-building method, the issuers indicate either a floor price or a price band within which the investors can place their bids. For executing the whole process, the issuers appoint the lead merchant banker (A bank
that deals mostly in (but is not limited to) international finance, long-term loans for companies and underwriting. Merchant banks do not provide regular banking services to the general public). The book runner appoints syndicate members

who collect bids from investors. Both retail and institutional investors can take part in the bid. The bids received from investors are recorded in a book in electronic form. The book runner, in consultation with the issuer company, evaluates the bids and decides the final price, which is also known as the cut-off price. The cut-off price is the price at which the demand for the shares meets the price. In case your bid is below the cutoff price, you will not receive any allotment. However, you can avoid this situation by submitting your bid without indicating any price. You have to simply indicate in your bid that you are ready to accept the offer of shares at whatever cut-off price the company fixes in the book-building process. This option is available only to retail investors and most of them submit their bid at the cut-off price.