How is an IPO valued?

All financial assets and securities have their own values based on the demand and supply in the market. This stands true even for newly introduced assets in the market. Privately owned businesses introduce their IPO (Initial Public Offering) to the public in the form of shares available for trading in the market to meet expansion plans and raise capital. However, many are left wondering about the reasons behind the valuation of an IPO, which depends on a variety of factors.

Before we read more about factors affecting the valuation of an IPO, it is important to know in detail what an IPO really is.

What is an IPO?

As can be inferred from the term, an Initial Public Offering (IPO), takes place when a private company initiates the process to publicly sell its shares for the first time. Once the IPO is declared in a stock exchange, the company no longer remains a private entity and is collectively owned by the shareholders.

A private company usually initiates an IPO with the intention of raising funds for expansion by way of selling a percentage of the company’s shares.

The response to an IPO largely depends on two factors, i.e. the company’s profile and the IPO valuation. Potential shareholders should carefully evaluate both these factors to realize the significance of an IPO.

Process of IPO valuation

A team of lawyers, underwriters, certified accountants and Securities and Exchange Board of India (SEBI) experts get together to value an IPO. This team compiles data and goes through the financials of a company, its assets and liabilities, revenue generation and performance in the market, besides other parameters. These data are thoroughly analyzed over a period of time before it is submitted for an official audit. Based on this audit, a prospectus is filed with the concerned stock exchange, an offering date is scheduled, and the price of the IPO is determined. All of this happens months before the issue is even declared.

Factors affecting IPO valuation

The following factors determine the valuation of an IPO:

• Number of stocks on offer: This helps understand the equation of demand and supply. By determining the number of stocks on offer, you can get a picture of whether it will be able to satisfy market demand.
• Administration of the company: The top-level management of the company going public plays a major role in the success of an IPO. A good team of higher-ups can assure better growth with higher resilience to shockers.
• Stock prices of competitors: This helps provide a reference mark for the IPO value. It also assists in closely understanding and predicting the market reception and consequent performance of the IPO.
• Company's revenue model: This is a fundamental factor considered for IPO valuation. A company’s revenue model is the foundation of its profit and loss. A better revenue model helps a company avoid losses and book a good profit. Hence, it is a very imperative while evaluating an IPO.
• Company's growth prospects: A team of underwriters closely monitors the future growth prospects of the company. It is on the basis of these prospects that shareholders choose to invest in the company’s IPO.
• Company's share in the sector: The company’s share to its sector gives an overview of how much revenue percentage the company would contribute to the sector’s total earnings. This largely affects the future value of the company.
• Market trend: Market movement plays an important role in strategically valuing the IPO. It is an external factor which affects every market player to a large or small extent.
• Overall economy: The overall factors that affect the economy in a country, including taxes, policies, and other events, have an effect on organizations as well and thereby affect the IPO valuation.

Moreover, the IPO of the company is sometimes strategically undervalued to get better reception from the market.