What is Initial Public Offering (IPO)

An initial public offering (IPO) is the process through which a private company offers its shares to the public for the first time. Before the IPO, the company's ownership is limited to founders, promoters, and early investors. After listing, the company becomes a publicly traded company, and anyone with a trading account can buy or sell its shares on a stock exchange.

An IPO allows investors to become a part-owner of the company. IPOs are regulated by the Securities and Exchange Board of India (SEBI) in India. A company that wants to launch the IPO submits all required details like price band, lot size and issue dates through a prospectus.

Why do Companies Go Public ?

The primary goal of launching an IPO is to raise capital. This money can be used for expansion, debt reduction, research, or entering new markets. Instead of borrowing money, companies raise funds by offering equity.

Many companies enter the market for brand visibility. Once a company is listed, it gains credibility and public trust. This helps in attracting customers, partners, and future investments.

The third reason for companies going public is giving an exit route for early investors. They can sell their shares during or after the IPO.

What are the Types of IPO ?

IPOs can be classified based on three factors: fundraising structure, pricing method, and listing platforms.

Based on the Fundraising Structure

• Fresh Issue IPO

  In a fresh-issue IPO, the company issues new shares, and the proceeds from the IPO go directly to the company. This fund is then used for company expansion, debt repayment and other administrative expenses.

• Offer for Sale (OFS)

  In OFS IPOs, existing shareholders of the company sell their shares either partially or fully. In this case, the company does not receive any funds; instead, they go to the investors who want to exit their positions.

Based on the Pricing Method

• Book Building Issue

  In a book-building IPO, the company sets the share price within a price band. Investors bid for their prices during the IPO subscription period. This type of IPO is most common in India.

• Fixed Price Issue

  In this type of issue, the company fix the share price in advance. During the IPO, investors must buy shares at the fixed price. This type of IPO is less common today.

Based on the Listing Platform

• Mainboard IPO

  The companies which are listed on the major stock exchanges, like NSE or BSE, are known as main board IPOs. These are usually well-established businesses with a strong financial track record.

• SME IPO

  An SME IP is designed for small and medium enterprises. These companies are smaller in size but try to raise capital for company expansion. An SME IPO typically has a lower issue size but a higher risk compared to mainboard IPOs.

How an IPO Works?

In India, companies follow the process below when they decide to go public. The company appoints an investment bank to help determine the valuation, price band, and overall structure of the issue.

The company submits a draft prospectus to SEBI for approval. After approval, the IPO dates are announced, and investors can apply for IPO during the subscription window.

During this window, investors bid for shares within the price range. Based on demand, shares are allocated through a process called IPO allotment.

Before the market opens on listing day, a pre open session takes place. This helps determine the opening price based on demand and supply.

Once listed, shares start trading on the stock exchange, and investors can choose to hold or sell based on market conditions.

Important Terms Associated with IPO

• IPO Subscription: It refers to the demand for shares during the issue period. If an IPO is oversubscribed, it means demand exceeds the number of shares available.
• IPO Allotment: It is a process of assigning share lots to investors after the subscription period.
• Price Band: It is the range within which investors can bid for shares.
• Lot Size: The minimum number of shares you need to apply for during an IPO application is called the lot size.
• Listing Price: It is the price at which the shares start trading on the listing day.
• IPO Grey Market: It refers to an unofficial market where shares are traded before listing.

Advantages & Disadvantages of Investing in IPO

Applying for an IPO can be rewarding, but it also comes with risks. The following are some key advantages of IPO:

• It offers an opportunity to invest early in a company's growth journey. Also, if the IPO lists at a premium price, then you will get a quick appreciation.
• Before going for listing, companies need to disclose financials and business details with SEBI and to the public. It increases the transparency, allowing you to make an informed decision.

However, IPOs are not risk-free. They come with the following risks:

• Some stocks may list at a discount or fall below the issue price.
• There is uncertainty in IPO allotment, especially in highly subscribed issues. Even if you apply, you may not receive shares.
• Relying on IPO grey market trends can be misleading, as they are unofficial and unregulated.

Things to Know Before Applying for any Upcoming IPO

• Read the prospectus to understand the business model, financial performance, and risks.
• Look at the valuation. Sometimes, even strong companies may be overpriced, which can affect post-listing performance.
• Avoid making decisions purely based on hype for new IPOs or recent IPOs performance.
• Ensure you have a demat account and sufficient funds before you apply for an IPO.

Frequently Asked Questions