What does Initial Public Offering (IPO) mean?
An Initial Public Offering (IPO) is a new issue of shares. The shares are admitted to a stock exchange for the first time and are offered publicly on the organized capital market. An IPO therefore enables the company to raise capital from investors via the public capital market. The transition from a private to a listed company usually means a share premium for existing shareholders.
How does an IPO work?
Before the IPO, the company is private. This means that the company’s shares are not publicly traded. Private companies usually only have a small number of shareholders. The shareholders are often the founders, family members or friends. In some cases, professional investors are also involved. A company needs money to grow. Going publicis one way of raising money externally. As a listed company must be transparent, it can also be easier for the company to raise external capital.
Before a company can go public, a price must be set for the shares. This takes place during the due diligence process by the banks accompanying the IPO. As soon as the company goes public, the shares of existing shareholders are valued via stock exchange trading(supply and demand) at the current public share price. Private shareholders can now keep their shares or often sell them on the stock exchange at a profit, as an IPO is often accompanied by a share premium.
In general, the IPO process consists of 3 phases. The first phase is the preparation phase. This is followed by the marketing and implementation phase. The last phase is the follow-up phase.
Source: Swiss Exchange – IPO Guide Switzerland
Motives for an IPO
An IPO can have several objectives. Three possible motives are explained below:
Financing
The IPO usually has a positive effect on financing. The additional equity can be invested to generate organic growth. The capital can also be used for external growth, i.e. acquisitions. Under certain circumstances, the equity ratio can also be strengthened by reducing debt.
Ownership structure
Another motive is the desired change in the ownership structure. If, for example, a major investor exits the company, the capital must be raised elsewhere. An IPO can therefore serve as an exit strategy for a financial investor, for example, and also diversifies the shareholder base. Stakeholders such as management or employees can also acquire a stake in the company more easily through an IPO or sell existing holdings.
Awareness
A possible third motive is the level of awareness and governance. An IPO can increase awareness of the company. After the IPO, the company is subject to disclosure requirements. This increases transparency and therefore also efficiency. In addition, companies are more likely to be considered in research by bank analysts after an IPO, which also increases transparency and awareness.
As a rule, the planned use of the new equity is described in the listing prospectus. The most frequently cited purposes for the use of funds in Switzerland are organic growth, external growth, debt reduction and financing of general business activities.
Advantages and disadvantages of an IPO
Advantages of IPO
- Capital procurement
- Attracting and retaining better managers and qualified employees through participation plans.
- Access to investments via the public capital market, which facilitates acquisitions and increases brand awareness and prestige. This in turn can have a positive impact on sales.
- Increased transparency (through mandatory reporting) can lead to more favorable credit conditions.
Disadvantages of IPO
- IPOs are expensive.
- Costs of maintaining the listed company.
- Increased time, effort and attention required from management (reporting)
- The disclosure of information may possibly benefit the competition.
- The strict management and control by the board of directors can make it difficult to find good managers who are willing to take risks.
Alternatives to the IPO
Direct quotation
With a direct listing, an IPOis carried out without a lead manager. A direct listing eliminates the underwriting process, which means that the issuer bears a higher risk if the offering is not successful. A direct listing is usually only possible for companies with a well-known brand and an attractive business segment.
Dutch auction
In a Dutch auction, the price for the IPO is not fixed. Potential buyers can bid for the shares they want and the price they are willing to pay. The bidders who are willing to pay the highest price are then allocated the available shares.