Last Updated on March 14, 2024 by ethinos
Any private company going public undergoes a process called Initial Public Offering (IPO), where shares are issued to retail investors for the first time. One of the critical aspects of an IPO is the IPO offer price.
Pricing an IPO’s shares appropriately is important to attract investors and ensure a successful launch. Too low, and the company will dilute its shareholding and be unable to raise enough capital. Too high, and investors will hesitate to invest.
In this article, we will discuss how is share price determined in an IPO, its risks, and evaluation methods.
Table of Content
Understanding an IPO Pricing
When a company decides to go public and offer shares to the public, it first needs to determine the price per share to launch its IPO. The IPO offer price can be either fixed or within a price band determined via the book-building process.
For fixed price issues, underwriters simply select a price at which investors must purchase shares. However, for book-building issues, a price discovery must take place. Investors submit their bids within a certain price band during the time the IPO is open. At the end of the bidding process, the company will determine a cut-off price at which it sells its shares.
To determine the optimal price, IPO issuing companies collaborates with financial institutions and experts who employ various methods to determine a fair range of prices. This process is involves finding a balance between the valuation a company wants and the perceived value of its shares. Merchant banks appointed by the company determine its IPO price based on various factors.
Additional Read: Why do companies go public?
Deciding the Final IPO Offer Price
When a company decides to go public, it must first hire underwriters to determine its proper valuation. To determine the company’s value, underwriters evaluate different factors like:
- What are the market conditions
- How many people want to invest?
- How similar companies are valued?
- What assets and liabilities does this company own?
Understanding these factors helps underwriters decide how much they should sell the company’s shares for. This price needs to be fair and attractive to investors. It also needs to include a fee for underwriters and any expected changes in the share price on the first day of trading.
Factors Influencing the Pricing of an IPO
Various factors can influence an IPO’s offer price. They are –
- The company’s growth prospects
- Financial health
- Industry trends
- Market sentiment
- The strength of the company’s management team
- Competitive positioning
- Number of stocks being sold
- Potential for future earnings growth
- The company’s brand recognition and values
- Its growth story and potential to disrupt the market
The overall state of the stock market, prevailing interest rates, and investor demand for similar offerings play a significant role in determining the IPO price.
Additional Check: Upcoming IPOs in India in 2024
Risks of Investing in an IPO
Investing in an IPO can offer substantial returns but is not without risks. You as an investor must carefully evaluate the company’s fundamentals, competitive landscape, and growth potential. Some risks involved include:
- Possibility of overvaluation
- Lack of historical performance data
- Unpredictability of public market reactions
- Potential for market volatility impacting the stock price shortly after the public offering
Pricing an IPO is a complex process that requires careful consideration. Companies and investment banks collaborate to strike a balance that maximises capital raised while attracting investors. Understanding the factors influencing IPO offer price, as well as the risks involved, empowers investors to make informed decisions.
Before investing, conducting thorough research, considering the company’s fundamentals, and seeking professional advice are essential factors to mitigate risks and enhance the potential for long-term gains. You can do your due diligence on our website as we provide all the necessary details of upcoming IPOs.
Frequently Asked Questions
The evaluation of an IPO is calculated through various methods, including discounted cash flow analysis, comparable company analysis, and market multiples. These methods assess the company’s financials, future earnings potential, and industry positioning to derive a fair valuation range.
The most significant advantage of an IPO for a relatively small business is the opportunity to raise substantial capital from public investors. This infusion of funds can help fuel growth, expand operations, repay debts, enable acquisitions, and enhance the company’s overall visibility and credibility.
Participating in an IPO carries risks such as market volatility impacting the stock price, potential overvaluation, lack of historical performance data, and the uncertainty of public market reactions. You should carefully analyse the company’s fundamentals and consult with financial advisors to assess these risks.
IPO shares are primarily sold through the investment banks and underwriters managing the offering. These institutions are responsible for listing the shares on the stock exchanges. They also distribute the shares to their network of institutional and individual investors via their retail brokerage platforms. You can access IPO shares through your brokerage accounts or participate in IPOs through allocated offerings.
