Advantages and disadvantages of underwriting

 Advantages and disadvantages of underwriting

In an IPO, which is often also referred to as an initial public offering, a privately held company lists its shares on a stock exchange making them available for purchase by the general public. Many people think that an IPO is a great opportunity to make money, because most of the prominent companies grab the headlines with huge stock price gains when they go public. But while this can be true, you must understand that IPOs are very risky investments, providing inconsistent returns or We understand that IPOs are extremely risky investments, providing inconsistent, regular or converging returns over the long term. Even for companies, while an IPO is a worthy goal with many potential benefits, there are also many risks and drawbacks associated with going public. Thus, an initial public offering may not be suitable for every investor or company. Although the IPO has many benefits, it also has many shortcomings. Let us now learn about the advantages and disadvantages of underwriting.

Before moving on to identifying the advantages and disadvantages of subscription, let us first know how it works and some related issues.
How does the subscription work?
Going underwriting and going public is a difficult and time-consuming process that most companies find difficult to navigate through its various steps on their own. A private company planning to go public not only needs to prepare itself for an exponential increase in public scrutiny, but it also has to file plenty of paperwork and financial reports to meet the requirements of the Securities and Exchange Commission (SEC), which oversees publicly traded companies.
This is why a private company planning an IPO hires a guarantor, usually an investment bank, to consult on the IPO and help it set an initial price for the offering. Underwriters help management prepare for the IPO, create key documents for investors and schedule meetings with potential investors, called roadshows.
Once the company and its advisors have set an initial price for an IPO, the underwriter issues the shares to investors and the company’s shares begin trading on a public stock exchange.
Why do companies go underwriting?

An IPO may be the first time that the general public can buy shares in a company, but it is important to understand the fact that one of the purposes of an IPO is to allow the early investors in a company to cash out their investment.
Think of an IPO as the end of one stage in a company’s life cycle and the beginning of another. Many of the original investors may want to sell their stakes in a new venture or startup. Similarly, investors in more established private companies that are going public may also want the opportunity to sell some or all of their shares.
There are other reasons for a company to seek an IPO, such as seeking to raise capital or to enhance the company’s public profile.
Companies can raise additional capital by selling shares to the public. The proceeds can also be used to expand business, fund research and development, or pay down debt.
Other ways to raise capital, through venture capitalists, private investors, or bank loans, may be expensive.
An IPO can also provide companies with an enormous amount of publicity.
Companies may want the prestige and attractiveness that often comes with being a public company, which can also help them obtain better terms from lenders.
While an IPO may make it easier or cheaper for a company to raise capital, it also complicates many other things. There are many disclosure requirements, such as submitting quarterly and annual financial reports. They must also answer all shareholder questions, and there are also reporting requirements for things like stock trading by senior executives or other moves, such as selling assets or considering acquisitions.
Underwriting terms
Like everything in the investment world, initial public offerings have their own terminology. If you are interested in investing in an IPO, you will need to understand the following key IPO terms:
Public Common Stock: Units of ownership in a public company, which entitle their owners to vote on company matters and receive company dividends. When going public, a company offers common common stock for sale.

Issue price: The price at which common shares will be sold to investors before the IPO company begins trading on public exchanges. It is usually referred to as the bid price.
Lot Size: The minimum number of shares you can bid on in an IPO. If you want to bid on more shares, you will have to bid in multiples of the lot size.
Prospectus: A document generated by an IPO company that discloses information about its business, strategy, historical financial data, recent financial results and management.
Price range: It is the price range within which investors can bid on the subscription shares, which is determined by the company and the contractor. They are generally different for each category of investor. For example, qualified institutional buyers may have a different price range than individual investors.
The subscriber or undertaker: the investment bank that manages the offering for the issuing company. The underwriter generally sets the issue price, publishes the IPO, and allocates shares to investors.
Investing in initial public offerings

Investing and buying shares in an IPO is not as easy as simply ordering a certain number of public shares. You will have to work with a brokerage firm that handles IPO applications, not all of them do.
Your choice of broker will depend on the companies you want to invest in and their nationality. When it comes to US stocks, brokers such as TD Ameritrade, Fidelity, Charles Schwab, and ETRADE may provide you with access to IPOs. As for when it comes to Saudi stocks, for example, the Al-Rajhi brokerage firm may provide you with access to new initial public offerings. However, in the case of many companies, you will need to meet certain eligibility requirements such as a minimum account value or a certain number of trades traded within a certain time frame.
Sometimes even if your broker provides access and you qualify, you may not be able to buy shares at the initial offering price. Retail everyday investors generally can’t snap up shares immediately after IPO shares start trading, and by the time you can buy the price could be astronomically higher than the listed price. This means that you could end up buying a stock for $50 a share that opened at $25, and miss out on significant gains early in the market.
As with any type of investment, putting your money into an IPO involves risk and it can be argued that IPO investments carry more risk than buying shares of public companies. This is because less data is available for private companies, so investors make decisions with more unknown variables.
For all the stories you’ve read about people making a lot of money from IPOs, there are many others that go the other way. In fact, more than 60% of IPOs between 1975 and 2011 saw negative absolute returns five years later. So, you should be careful before making any decision regarding investing in IPOs and take your time to research.
Advantages and disadvantages of underwriting
An IPO offers a lot of benefit to companies that intend to go public, however this benefit also comes with some difficulty and shortcomings. Let us now learn about some of the advantages and disadvantages of underwriting. 
Subscription features

The most important advantage of underwriting is money. In 2016, IPO proceeds averaged $94.5 million, and several offerings have brought in hundreds of millions of dollars. For example, in 2016, the largest IPO of ZTO Express brought in $1 billion. The IPO proceeds provide the justification for many companies to go public even without regard to the other benefits especially given the many investment opportunities available due to the new capital. This money can benefit a growing company in countless ways. Companies may use an initial public offering to fund research and development, hire new employees, build buildings, reduce debt, and finance expenses capitalism, the acquisition of new technology or other businesses, or the financing of any number of other possibilities. The money an IPO saves is significant and could change the course of a company’s growth.
chance to get out
Every company has stakeholders who have contributed large amounts of time, money, and resources in the hope of creating a successful company. These founders and investors often hold out for years without seeing any significant financial return on their contributions. An initial public offering is a great exit opportunity for stakeholders, as they can get huge amounts of money, or at least, monetize the capital they have currently tied up in the company. As mentioned in the previous paragraph, initial public offerings often raise close to $100 million (or even more), and this makes them very attractive to institutions and initial investors who often feel that the time has come to receive financial compensation for years of patience. However, it is important to note that in order for the founders and investors to obtain liquidity from the IPO,They have to sell their shares in the currently public company on a secondary exchange. Shareholders do not receive liquidity immediately from the IPO proceeds.
Publicity and credibility
If the company hopes to continue to grow, it will need to increase exposure to potential customers who know and trust its products. An IPO can provide such exposure as it pushes the company into the public spotlight. Analysts around the world report on every initial public offering to help their clients know whether to invest or not, and many news agencies draw attention to the different companies that go public. Not only do companies receive a great deal of attention when they decide to go public, but they also gain credibility. To complete an offer, the company must undergo extensive vetting to ensure that what they report about themselves is correct. maybe This scrutiny, combined with the tendencies of many individuals to overtrust public companies, increases the credibility of the company and its products.
Reducing the total cost of capital
The main hurdle facing any company, especially younger private companies, is the cost of capital. Before going underwriting, companies often have to pay higher interest rates to get loans from banks or give up ownership to receive money from investors. An IPO can greatly reduce the difficulty of obtaining additional capital. Before a company even begins the process of preparing for an IPO, it must undergo scrutiny according to exact criteria. This audit is usually more thorough than any previous audits, and builds confidence that what the company is reporting is accurate. This increased security is likely to result in lower interest rates on loans received from Banks, as the company is seen as less risky. On top of lower interest rates, once a company goes public, it can raise additional capital through subsequent offerings on the stock exchange, which is usually easier than raising capital through a private funding round.
Underwriting defects
regulatory requirements
Unlike private companies, public companies are required to file their financial statements with the Securities and Exchange Commission (SEC) every year. These financial statements must be prepared in accordance with generally accepted accounting principles in the United States and audited by a certified public accounting firm. These SEC regulations are cumbersome and costly. Publicly reporting a company’s financial health requires that company put in place stricter financial controls, employ a financial reporting team and audit committee, perform quarterly and annual financial disclosures, and complete hundreds of other tasks. These responsibilities cost public companies millions of dollars each year and require thousands of hours of work.
market pressures
Market pressures can be very difficult for company leadership who are used to doing what they think is best for the company. Founders tend to have a long-term vision, with a vision of what their company will look like years from now and how it will impact the world. On the other hand, the stock market has a very short-term, profit-driven view. Once a company goes public, its every step is scrutinized by investors and analysts around the world, who are generally concerned with one question:”Will this company meet its quarterly earnings target?” If the company achieves its goal, its share price will naturally rise; If it doesn’t achieve that, its share price will will go down. Even if leadership does what is best for the company in the long run, failure to deliver on short-term goals for the public may cause the company to lose value and leadership may be replaced as a result. Founders who don’t like the idea of ​​being tied down to broad, short-term goals should think twice about taking their company public.
Possible loss of control
One of the main disadvantages of going public is that the founders may lose control of their company. While there are ways to ensure that the founders retain the majority of decision-making power in the company, once the company goes public, the leadership needs to keep the public happy even if the other shareholders don’t have the right to vote. Going public means receiving large sums of money from public shareholders. Because the shareholders have given the company so much money, they expect  the company to act in their best interest, even if that means going in a direction the founders don’t like. If shareholders feel that the company is not operating in a way that helps them make money, they will force the company, through shareholder vote or public criticism, to appoint new leadership.
Big expenses
Initial public offerings are expensive. In addition to the recurring expense of a public company’s regulatory compliance, the IPO process comes at a significant cost. The biggest cost of going public is the insurance fee, with underwriters typically charging between 5% and 7% of the total proceeds meaning the underwriter discount can cost up to $7 million on the average IPO. On top of insurance fees, companies collecting the average amount of revenue (around $100 million) should expect to spend about $1.5-2 million in legal fees, $1 million on auditor fees, and $500,000 on filing and printing fees. Transaction costs will be higher if the company chooses to hire a financial reporting advisor, or other specialist groups.
These were some of the advantages and disadvantages of an IPO that companies should consider before making the decision to offer their shares to the public. In addition to the advantages and disadvantages of IPO for companies, the IPO has many advantages and disadvantages even for investors.. The biggest disadvantage is that it involves great risks due to the lack of information about the company and the many requirements to participate in it.
Disclaimer: The content of this article is for informational purposes only. The information provided should absolutely not be considered as investment advice or a recommendation. No warranty is made, express or implied, as to the accuracy of the information or data contained herein. Users of this article agree that Money Secrets does not accept responsibility for any of their investment decisions. Not every investment or trading strategy is suitable for anyone. See the risk warning statement.

Scroll to Top