Is IPO Safe?

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Initial Public Offer (IPO) is the process in which a private company goes public after offering its shares to a large number of shareholders at the same time, thus raising huge amounts of money.

Generally, it is perceived that IPOs offer shares at discounted prices. There have been many examples in the past where the investors who invested in IPOs made fortunes due to high rises in the stock price. Some people even used to refer to IPOs as money making machines.

But this statement proved to be a myth after the failures of some IPOs which were being considered extremely promising before their launch. Thus, it is not always true.

For example: In the year 2008, when the IPO of Reliance Power was about to be launched, people saw no reason for hesitation towards buying it. Many took loans to invest in IPOs. Previously, the IPO of Reliance had earned enormous amounts of money for its investors.

Therefore, people had a sort of confidence in Reliance Power as well and were hoping that the history would repeat itself. However, the results of this hope were disappointing and the Reliance Power IPO failed miserably leaving so many people in losses.

There are similar examples which prove that “safety of IPOs” is a myth and that is why we are discussing this million dollar question – Is IPO Safe?

To be brutally honest, there is an element of risk always involved with investing in IPOs. Without further ado, let us discuss some factors that have a detrimental effect on the safety of IPOs:

No History of Trading:

Since it is an IPO, its shares are listed on the stock exchanges for the first time, there is no history behind it. We do not know its usual highs and lows. We do not have any trend to analyse and make calculated guesses about its future. If the market or economic conditions change, there is a good probability of a decline in prices of the stock.

Thus, both internal factors that decide the past growth in the company, as well as external micro & macroeconomic conditions, play a huge role in determining the success of an IPO.

A Little Less Experience Than Counterparts:

The companies that go for IPOs are generally small and fast growing. They are generally smaller and less experienced than their competitors which are already in a stable phases of their growth. Management teams are more experienced in handling different situations related to the business as well as the market.

Therefore, for the companies launching their IPOs, there is always some amount of scepticism about their performance and stability. At the same time, it is actually good to have a small percentage of doubt and confusion. This keeps the management of the company to stay away from getting overconfident and thus, unrealistic.

Shares sold to Institutional Investors First:

This is one of the most important factors that hinder in the safety of IPOs. Usually, shares launched in IPOs are first sold to institutional investors (commercial banks, mutual funds, hedge funds, endowment funds, pension funds, insurance companies). After the trading of the stock begins, these institutional investors are at liberty of selling their stakes at, below or higher than the offer price.

In IPOs that are highly awaited, or much hyped and publicised, there is a good possibility of extraordinary rises in share price. When the general public enters the market at this level by buying high priced shares, it becomes more probable of them suffering losses.

Effect on Business Due to IPO Related Factors:

Now, when an IPO is being launched, there are very stringent SEBI requirements that need to be fulfilled. Even after the launch of the IPO, it is an ongoing process. Filings need to be filed regularly. All the business related information needs to be shared with the public.

The increase in costs related to various advisors hired to launch the IPO and a great increase in regulatory oversight might have impacts on the functioning of the company. This may affect its profitability and ultimately, its share price, which may prove a threat to the safety of IPOs investment.

Despite all these factors, there have been IPOs like Infosys, Wipro and Maruti have done wonders for their investors. Ultimately, it is a matter of good decision making by striking a balance between risks involved and good tips to invest in IPOs.

The whole idea of this detailed article was to keep you aware of the other side of the coin, which will not be told to you explicitly. Having said that, it is important to perform an analysis of the company or read the ones done by financial experts. This small exercise of 3-4 hours will make you confident on whether to go ahead with the IPO investment or not.

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