The term initial public offering (IPO) is common within the startup community. When a new company begins selling its shares to the public, it generally receives favorable feedback.
To reach the IPO phase, startups must have completed multiple funding stages, beginning with pre-seed, seed funding, Series A, B, and C, and possibly additional rounds. What does this indicate? It is reasonable to assume that a startup has generated consistent profits prior to its initial public offering (IPO).
What is an IPO or Initial Public Offering Definition?
Initial public offering (IPO) refers to the first time a company offers its shares to the general public. In other words, it is when the company’s stock begins trading on a stock exchange.
The shares of a publicly traded company are available to anyone who meets the criteria.
A private limited company becomes a public limited company through an IPO. This is not solely about stocks. Unsurprisingly, when a company conducts an IPO, the event is commonly known as “going public.”
Also read: What is Bootstrapping in Startup? Here’s The Pros and Cons
The Objective of an IPO
Comprehending a company’s IPO, its objectives, and its terms (source: Freepik).
An IPO is a significant step for the company. But what is the objectives of IPO? Is it to increase profitability?
Each company’s IPO has a unique purpose. Typically, companies conduct IPOs to raise capital from the public as investors. These additional funds may be applied to operational endeavors, the investigation of new business opportunities, etc.
By going public, the business hopes to increase public confidence and facilitate loan access. The public has a more favorable perception of IPO companies, and they are subject to lower taxes.
A secondary goal of an IPO could be to increase the company’s value over time. An increase in the company’s value will benefit its products, human capital, and growth.
Therefore, corporations must decide when to offer shares to the public or conduct an IPO. The optimal time is when both the stock market and the company’s business are flourishing. Prior to launching an IPO, one must also consider the national and international economies.
Also read: The Importance of Business Incubators for Entrepreneurs
Requirements for Companies that Wish to Conduct an IPO
There are some requirements for companies that wish to conduct an IPO. Here’s the explanation.
1. Financial and accounting specifications
A company must have been in operation for at least a year and have a solid financial foundation in order to conduct an IPO. The structure and content of their financial statements and accounting reports must adhere to the regulations.
2. Complete company leadership structure
Investors must examine more than just a company’s financial reports. They must also examine the company’s management.
People will not invest in or buy the stock of a company if its leadership structure is unclear or consists of individuals with poor track records.
3. Minimum IPO offered
The company must also offer the minimum number of shares, which is 500 investors, and the required number of shares, which is 150 million shares, in order to conduct an IPO.
IPO Mechanism
It is necessary to have a comprehensive understanding of the IPO mechanism and procedure, as well as the parties involved. What are those particular elements, and how do they work?
1. Auction Mechanism
Two auction models are included in the initial public offering (IPO): the single-price auction and the discriminatory auction. In an auction, multiple individuals who wish to acquire shares do so at predetermined intervals in an effort to obtain the best price for the offering.
In a single-price or uniform-price auction, regardless of the price posted during the auction, all winners receive the same price.
In a Dutch auction, also known as a discriminatory auction, the winner pays the price listed. In a number of nations, this type of auction is used for the initial sale of government bonds to the general public.
2. Fixed-price Offering Mechanism
Investors are required to agree to a predetermined price. The issuers offer a specific number of shares at a fixed price, regardless of the number of requests.
If there is greater demand than supply, the stock exchange will allocate it fairly. This mechanism tends to offer a lower price in order to increase sales.
3. Book-building Mechanism
The book-building mechanism differs from the other two in that it requires a third party to purchase shares from the issuer and guarantees the sale of a specific number of shares through their distribution network. This deal is a bought deal. It entails a financial guarantee contract, also known as “credit insurance.”
Also read: Series A Funding and the Impact for Startup Companies
IPO Undertaking Process
After fulfilling the requirements, companies wishing to conduct an IPO will go through the following process:
1. Cooperation with underwriters
Companies are required to work with underwriters to submit proposals, determine prices, and select securities to sell. The underwriter ensures compliance with all regulatory requirements and sets the initial offering price for the company’s stock. In addition, underwriters play a role in assisting companies with going public.
2. Submission to IDX and OJK
In Indonesia, a company can send the required documents to the IDX and OJK, such as company profiles, financial statements, and other legal documents, if they have them. Papers will be checked and analyzed by the IDX team. If the company’s documents meet IDX standards, they will be approved for listing.
After the submission, the company, the underwriter, and other people involved will be called in to validate the process and decide if the IPO needs to happen. The IDX will also visit the company to check its eligibility.
3. Launch IPO on schedule
If the submission process has been well carried out, the IDX will issue a “Preliminary Listing Agreement.” Afterwards, IDX will help with the IPO undertaking process by determining the bidding schedule. The schedule will be published on IDX’s official website, and the public can buy shares following this schedule or pre-order them by subscribing.
Another option for the company is to sell the shares directly to the public, and the underwriter(s) will try their best to sell them. This method is called “best-effort underwriting,” in which no party is responsible for shares that are not sold because they will be returned directly to the company.
Pros and Cons of IPOs
Comprehending a company’s IPO, its objectives, and its terms (source: Freepik).
Although it can be considered the ultimate goal of a company, initial public offerings (IPOs) have two sides.
Read on to learn about its advantages and disadvantages.
Benefits of IPO
1. Getting additional capital
With the submission of the IPO, the company will receive additional capital. The capital market will serve as a funding source. The obtained funds are not subject to interest. This capital can be optimally utilized for business development without the need for loans.
2. Improving company image
Companies already listed on a stock exchange will have a greater opportunity to demonstrate their best performance and build a positive reputation, for example, through product innovation, as a result of increased exposure.
3. Access to loans
After completing an IPO, the banking industry will gain more confidence in a company. As a result, the availability of short- and long-term loans is increased. Companies will also find it easier to issue debt securities, as the public always favors well-known firms with a solid reputation.
4. Getting tax incentives
There is an additional incentive for businesses to go public: income tax reductions. In Indonesia, the rate becomes 5% lower than the rate for domestic corporate taxpayers if both of the following conditions are met: (1) at least 40% of the company’s total shares are listed and traded on the stock exchange; and (2) the company has at least 300 shareholders.
Also read: Understanding Series B Funding for Startups and The Example
Downsides of IPOs
1. It costs a lot
To apply for an IPO, a company must pay a substantial fee and wait a considerable amount of time. Administration, underwriters, legal consultants, notaries, and other expenses incur considerable costs. Consequently, the majority of companies that conduct an IPO are large enough to cover these expenses.
2. Co-ownership
With the influx of public investors, the company is no longer owned by its founding members. The general investor will be responsible for determining the direction of the company.
Founders can remain controlling shareholders so long as they own more than 50 percent of the company’s shares or have the ability to manage a public company.
3. Tangled with capital market regulations
The company is constrained by capital market regulations as a result of undertaking an IPO. IDX and OJK impose stringent regulations on companies whose shares are listed on their respective stock exchanges. The business license can be revoked for violations. This rule ensures that all shareholders have access to the necessary information to make the best investment decisions.
There are numerous aspects of initial public offerings (IPOs) that you must understand. Hopefully, this article will help you comprehend how an IPO operates and give you a sense of how to go about undertaking one!
