What is IPO?
Initial Public Offering (IPO) is the bridge between private growth and public legacy. Learn how companies scale and how you can participate in their journey.
Overview
Types
Pros & Cons
Process
Key Terms
Eligibility
FAQ
Overview
Initial Public Offering (IPO) refers to the process where private companies sell their shares to the public to raise equity capital from the public investors. The process of IPO transforms a privately-held company into a public company. This process also creates an opportunity for smart investors to earn a handsome return on their investments.
Investing in IPOs can be a smart move if you are an informed investor. But not every new IPO is a great opportunity. Benefits and risks go hand-in-hand. Before you join the bandwagon, it is important to understand the basics.
What is IPO in Stock Market?
IPO stands for Initial Public Offering. Initial Public Offering (IPO) can be defined as the process in which a private company or corporation can become public by selling a portion of its stake to the investors.
An IPO is generally initiated to infuse the new equity capital to the firm, to facilitate easy trading of the existing assets, to raise capital for the future or to monetize the investments made by existing stakeholders.
The institutional investors, high net worth individuals (HNIs) and the public can access the details of the first sale of shares in the prospectus. The prospectus is a lengthy document that lists the details of the proposed offerings.
Once the IPO is done, the shares of the firm are listed and can be traded freely in the open market. The stock exchange imposes a minimum free float on the shares both in absolute terms and as a ratio of the total share capital.
Types of IPO
Fixed Price Issue
Here, the company and underwriters analyze its liabilities, assets, and other financial data. They then fix the price per issue accordingly to achieve the targeted capital. The order document will justify the price with quantitative and qualitative aspects. Demand for securities will only be known once the issue is closed. Oversubscription levels are sometimes high for fixed price offerings.
Book Building Issue
Here, the price discovery takes place during the IPO process where there is no fixed price, but a price band. The lowest price here is the floor price and the highest one is the cap price. Investors may submit bids for their chosen share quantity at the price they wish to pay. Depending on these bids, the share price is fixed and securities are offered either above/equal to the floor price. Demand is known each day as the book building takes place.
Fixed price methods may undervalue the shares of the company at the IPO, with the price mostly lower than the market value. Hence, they sell more and investors revalue the company positively accordingly. The book building system may ensure higher efficiency, matching the supply and demand of the shares before the price is fixed, without leaks. The company gets a fairer return and investors an upside since the price fixing takes place after the IPO closes.
Advantages & Disadvantages
Benefits
Increased Recognition
Gaining credibility and media attention.
Access to Capital
Raising substantial cash for growth and R&D.
Exit for Founders
Providing liquidity for original stakeholders.
Risks
Increased Compliance
Stricter regulations and quarterly filings.
Market Volatility
Stock price exposure to market sentiment.
Dilution
Founders have less control over the firm.
IPO Process
01
Bank Recruitment
Underwriters analyze financials and sign agreements.
02
Filing RHP
Filing registration statements with SEBI.
03
Roadshows
Marketing the IPO to institutional investors.
04
Pricing & Listing
Discovery of final price and trading commencement.
Terms Associated with IPO
To have informed knowledge about IPO, it is necessary that one comes to know about some basic terms used in the process. Some of the commonly used terms are provided in the table below:
| Terms | Descriptions |
|---|---|
| Issuer | An issuer can be the company or the firm that wants to issue shares in the secondary market to finance its operations. |
| Underwriter | Banker, financial institution, or broker that assists the company to underwrite stocks and commits to subscribing to balance shares if needed. |
| Fixed Price IPO | The issue price set by companies for the initial sale of their shares. |
| Price Band | A value-setting range (upper and lower cost limits) within which interested buyers can place their bids. |
| DRHP | Draft Red Herring Prospectus: The document informing the public about the IPO listings after SEBI approval. |
| Under-Subscription | When securities applied for are less than the number of shares made available to the public. |
| Oversubscription | When the number of shares applied for exceeds the number of shares offered. |
| Green Shoe Option | An over-allotment agreement permitting underwriters to sell more shares than initially planned if demand is high. |
| Book Building | The process of determining the IPO price based on bids from institutional investors and fund managers. |
| Flipping | The practice of reselling IPO stock in the first few days to earn a quick profit. |
IPO Eligibility
Any individual who is an adult and is capable of entering into a legal contract can serve the eligibility norms to apply in the IPO of a company. However, there are some other inevitable norms an investor needs to meet.
The eligibility criteria are:
It is required that the investor interested in buying a share in an IPO has a PAN card issued by the Income Tax department of the country.
One also needs to have a valid demat account.
It is not required to have a trading account, a Demat account serves the purpose. However, in case an investor sells the stocks on listings, he will need a trading account.
It is often advised to open a trading account along with the Demat account when an investor is looking forward to investing in an IPO for the first time.
FAQs
An initial public offering is when a private firm sells its first shares to the public.
It can be, but success depends on company valuation and market timing.
Investing in an IPO can be a good decision. If you get in on the ground base of a stock with tremendous upside potential, you could reap the benefits later on as the price appreciates over time.
If you want to sell shares from an IPO on the day of the listing, you can do so during the pre-market session. When you choose the option of selling your share, you must set certain parameters, such as the price at which you desire to sell the share, among other things, after you are listed.