How is the issue price of an IPO decided?
12 January, 2025
Synopsis
An IPO share price is a price at which a company initially offers its shares to the public during an IPO.
Applicants must apply for shares at a price that lies within the IPO price band.
Investment bankers or underwriters of the IPO determine the price band of the IPO.
IPO is a process through which a company attains a listing on a stock exchange by offering its shares to the public for the very first time. Considering the importance of this event, companies often hire investment banks who help them to initiate the IPO process. In turn, these banks help companies navigate past regulatory compliances and also help determine the price of their shares. But how exactly is the issue price of an IPO determined?
What is the IPO share price?
An IPO share price is a price at which a company initially offers its shares to the public during an IPO. It can also be described as the cost that investors are required to pay to acquire shares and become partial owners of the company. The IPO share price is set by the company and its underwriters by evaluating various factors including the company’s finances, market conditions, investors’ demand, industry trends, and valuation methods. The IPO share price also helps the company determine the value of funds that can be raised by selling its shares, establishing the company’s market capitalisation.
What is the role of investment banks in an IPO process?
Investment banks act as underwriters in the capital-raising efforts of the company. They assist companies by managing numerous aspects of the IPO process including share price valuation. The role of underwriters involves providing financial expertise, conducting market analysis, ensuring regulatory compliance, and understanding investors’ sentiments. The underwriters negotiate the IPO price with the company based on their analysis to arrive at a price that both the company and underwriters think is fair and attractive to investors.
How is the IPO issue price decided?
Most IPOs come with a price band. Applicants to the IPO have to apply for shares at a price that lies within this price band. After the applications have been received and the bidding period ends, the price at which the shares in the IPO will be issued is determined by a process known as book-building process. Weighted average price is determined in the book building process based on the applications received at various price points within the IPO price band.
In some IPOs issue price is simply a fixed price determined beforehand. Applicants to the IPO simply apply at this fixed price.
What are the key components in IPO price valuation?
In IPO price valuation investment bankers or underwriters of the IPO determine the price band of the IPO. They take in the following factors while determining the price band.
Company profile
In-depth research of the company is conducted, one which includes its business model, products or services, customer base, management approach, and past records. An effectively operated company and a well-managed one can attain higher valuation due to investor confidence.
Industry and market analysis
The company’s industry dynamics and market conditions can significantly influence the IPO price. A deep analysis of industry trends, market dynamics, and macroeconomic factors helps to identify the company’s performance gaps and its alignment with growth prospects within the sector.
Demand
Evaluating demand for the company’s shares is the most crucial aspect of an IPO valuation. It involves assessing investor sentiments, the level of interest in the IPO, and the demand exhibited during the book-building process (if followed). High demand indicates a higher IPO share price, whereas tapered demand could lead to a reduced valuation of the issue price.
Growth prospects
Investors focus on growth; therefore, they stay highly interested in the company’s financial growth potential. Factors like past revenue, profit, expansion plans, entry into new markets, research, and innovation can impact the company’s growth prospects. Investors show great interest in companies with promising growth trajectories and hence, can be willing to pay a higher amount for their shares.
Risk factors
A comprehensive assessment of risk factors is executed to determine the level of risk involved in the IPO process. Factors like industry-related challenges, regulatory hindrances, competition, and economic uncertainties play a significant role in assessing the potential risks.
Discounted cash flow (DCF) analysis
DCF involves estimating the present value of a company’s future cash flow. It considers projected revenue, expenses, and discount rates to determine whether the future cash flows from an investment are worth it in today’s scenario.
When considering participating in an IPO, assess the price along with other information provided in the IPO prospectus. The IPO price reflects the company’s current standing. As an investor, understanding the factors that contribute to IPO issue price valuation can provide you with valuable insights into determining the potential return on investment in an IPO.
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*Disclaimer: The information provided in this article is generic in nature and for informational purposes only. It does not make any recommendation to act. It is not a substitute for specific advice in your own circumstances. You are recommended to obtain specific professional advice before you take any/refrain from any action. Investments are subject to market risks and other risks.
