An Initial Public Offer (IPO) is a method of financing through which private company transitions to a public company. The IPO process involves inviting the general public and investment institutions to subscribe to the issue of shares in exchange for funds. The company sells its equity to the public in order to raise funds for various purposes like financing a new project or scaling the business or giving an exit to early investors and promoters.
IPO valuation meaning and process
Investing in IPOs has gained popularity recently. Although IPOs are a great investment opportunity and allow investors to invest in a company early on in its growth cycle, it is crucial to consider factors like the IPO valuation.
When a company comes out with an IPO, its shares must be fairly valued. The price of the shares and the valuation of the company when the IPO opens are known as the IPO valuation.
The valuation of the IPO is done by its investment bankers or underwriters. These entities go through the company’s financials, like the assets, liabilities, performance and the ability to generate revenue. The data is carefully analyzed over a period and is sent for an audit. After the audit is completed and a price is determined, a prospectus is created and filed with the market regulator Securities & Exchange Board of India (SEBI) and stock exchanges.
How is the IPO valued?
Apart from knowing the meaning of what is an IPO valuation, it is also helpful to know how is an IPO is valued. Investment bankers and underwriters carefully consider a few factors in order to find a fair valuation for the IPO.
- Potential for growth: An investor would want to invest in a company that has substantial growth potential. The valuers consider this as a prominent factor while analyzing a company in order to value the IPO.
- Demand for shares: One of the main factors is the demand for an IPO. The demand for the shares of the company from retail investors, as well as larger institutional investors, is considered to value the IPO.
- Peers in the industry: While valuing an IPO, the company’s shares are compared against those of other companies in the same industry and their IPO price bands or valuations.
IPO Valuation Methods
In order to value an IPO, there are a few IPO valuation methods that can be used.
Absolute valuation method of an IPO makes use of Discounted Cash Flow (DCF) analysis in order to measure and asses a company’s wealth. This method is primarily used to ascertain the company’s financial strength in order to come up with a fair value for the IPO.
Relative valuation method considers the value of similar companies and competitors. The valuers use the other companies as a benchmark in order to fairly value the company’s IPO.
Discounted cash value-based valuation
This method of IPO valuation considers the future performance, cash-flows, revenue and business investments. This method of valuation is tedious as it is difficult to ascertain the future performance of the company.
The economic method of IPO valuation makes use of mathematical models with various parameters like the value of assets, liabilities, residual income, debts etc., in order to value the IPO.
Factors which influence pre-IPO valuation
There are several factors that are taken into account and affect the pre-IPO valuation of a company.
- The size of the IPO and the number of shares being sold
- The management and organization of the company coming out with the IPO
- Growth potential of the company
- The financial performance and business model of the company
- Potential demand for the IPO from investors
- The price of the shares of similar companies
- The current trend of the market
In conclusion, IPO valuation is important for both the company as well as the investors. A company needs to fairly value the IPO in order to attract investors. An investor should consider the IPO valuation and be wary about applying for an overvalued IPO.
What are the criteria for the IPO?
A company proposing to launch an IPO must comply with certain requirements of the relevant stock exchanges on which it intends to list its shares. It also has to comply with the eligibility requirements laid down by SEBI in the ICDR Regulations and the Listing Regulations. Moreover, the company must also comply with rules under the Companies Act 2013, the Securities Contract (Regulation) Act 1956 and the Securities Contract (Regulation) Rules 1957.
Are IPOs always profitable?
There are several micro and macroeconomic factors that affect the price and value of a share. Some IPOs may not perform well and might not be profitable. Therefore, it is important to manage your risk and do proper research and analysis before applying for an IPO.
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