Initial Public Offering (IPO) refers to the first time a private company floats its stock on the stock exchange market. Once the IPO takes place, the company ceases to be a private company and makes the transition to a publicly traded company, which makes it possible for the public to buy their shares. In so doing the company is able to raise money and increase their liquidity, helping them to expand or make infrastructural re-investments. Often times, IPOs are issued by small and young companies that are looking to raise money to facilitate their growth and expansion. Older larger firms that are privately traded and would like to be publicly traded can also issue an IPO. Once an IPO takes place and the company goes public, it acquires general shareholders, it is consequently subjected to the rules, and regulations put in place by the Securities and Exchange Commission.
Role of the Investment Banker and Underwriter
During the IPO process, the company making the issue (issuer) engages the services of an underwriter or an investment banker to help them decide on three key matters: the kind of security they can issue, the best time to make the sale and the best price for the offering(Lipman, 2009). This engagement with an investment bank or several investment banks is known as underwriting, and further serves to distribute the risk and the funding for the IPO. Underwriting firms such as Morgan Stanley or Goldman Sachs proposebids to the company intending to hold the IPO indicating the amount of money the company is likely to make and what the bank will be taking away from the transaction.
Role of the Originating house and a Syndicate
In the underwriting process, an investment brokerage firm that is part of managing the underwriting and selling the companies new stock issue during the IPO is referred to the originating house. When the originating house forms temporary associations with other investment brokerage firms they form a purchase group or what is otherwise known as a Syndicate. A syndicate is formed for the purpose of selling a company’s new stock to the public during the IPO by buying the new offering from the issuer and reselling to the investing public at a markup(Khurshed, 2011). The originating house is charged with the mandate for managing the syndicate. The involvement of a syndicate ensures that the risk of loss during the IPO is reduced and that maximized profits are locked in since every member of the syndicate attracts more buyers.
An explanation of the pricing of the issue
Like in any other market, the pricing during an IPO is also affected by the forces of demand and supply. IPOs are however unique in that the involvement of an underwriting firm in the process is charged with analyzing and making comparisons of similar companies in the market in order to come up with the most viable price for the issue. Multiple valuation methods such as discounted cash flow and dividend-discount model valuation are used in the process(Khurshed, 2011). They also consider investor appetites by analyzing potential investors and the potential demand for the stocks.In as much as the goal of an IPO is to raise money, it also serves to build the foundation for favorable relationship between the company and the new shareholders, this is factored in during price setting.
Risks involved in the public offering and how securities laws deal with them
IPOs are risky business and especially to an individual investor because it is difficult to analyze a company and make any short term or long term predictions of how its stock is likely to perform, without any available historical data. The fact that most companies issuing an IPO are often in a period of transitory growth makes the future of the company even more uncertain, further heightening the levels of risk, and complicating the decision to invest.
When companies see opportunities in foreign markets where they can gain access to more liquidity, they aim to have their company publicly listed in those markets. Certain countries offer more favorable IPO environments than others do, for instance, the U.S. allows for dual-class structure of ownership, which is advantageous to companies due to the uneven voting rights that favor management. However, there are risks to a company associated with the company’s pre-IPO overvaluations, information asymmetry and country risk, which may result in post-IPO underperformance. Continued post-IPO underperformance, which falls below the requirements of the exchange performance, may lead to eventual delisting and reflect negatively on the company. Due to investor fears of financial fraud and other concerns, a company seeking to be listed in a foreign country may be forced to underprice the issue and fail to meet their targeted returns(Lipman, 2009).
To mitigate some of these challenges, securities laws make it necessary for a company seeking to be listed in a foreign stock market to be as transparent and complaint to standards as possible in order to reassure potential investors. The laws ensure that companies adhere to set standards and comply with requirements regarding financial reporting, while making sure that in their case scrutiny is heightened.
Foreign exchange risks the company can face and ideas of how to mitigate them
Companies operating outside their home markets and that have a heavy reliance on specific exchange rates such as those that deal in the import or export business, usually have increased exposure to foreign exchange risk. This is because any investment subject to currency exchange rate will mean either an increase or decrease of the value of the investment during sale or conversion to its initial currency.Depreciation in foreign exchange rate negatively affects a company’s revenue growth by undermining its products competitiveness and subsequently weakens the valuation of the company(Papaioannou, 2006).In order for a foreign company to safeguard itself from risks associated with exchange rates, it is necessary that it put in place hedging contracts that can sufficiently absorb any unanticipated fluctuations in exchange rate.
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