What Is an IPO?

An Initial Public Offering (IPO) is a process where a private company decides to offer its shares to the public for the first time. This allows anyone, from individual investors to large institutions, to buy a part of the company and become a shareholder. Once the IPO is completed, the company’s shares are listed on a stock exchange like the Bombay Stock Exchange (BSE) or the National Stock Exchange (NSE) in India, making them available for buying and selling.

Example:

Think of it like a local bakery that has been doing well for years and decides to sell a part of the business to raise funds for expansion. By doing so, anyone interested can buy shares of the bakery and become part of the business.

An IPO can be divided into two categories:

1. Fresh Issue – The company issues new shares to raise capital.
2. Offer for Sale (OFS) – Existing shareholders, such as the company’s founders or investors, sell their shares to the public.
   
   

Why Invest in IPOs?

Investing in IPOs can be appealing, especially for beginners. Here’s why people often consider investing in IPOs:

1. Opportunity to Buy Early

When a company goes public, it offers a chance to buy its shares before they are available on the stock market for general trading. If the company grows well, early investors can see significant returns.

2. Potential for High Returns

Sometimes, the stock price of a company can skyrocket after an IPO. For example, when companies like Zomato and Nykaa went public, many early investors made substantial gains as the stock price increased.

3. Portfolio Diversification

If you already have investments in other areas, adding IPO shares to your portfolio can spread the risk and increase your chances of higher returns. This is important in managing risk.

4. Long-Term Growth

By investing in an IPO, you are not just looking for short-term profits. Some IPOs offer long-term growth potential, allowing investors to build wealth over many years.

5. Support Growing Companies

When you invest in an IPO, you help the company raise funds for its future expansion. It’s like supporting a young startup with great potential.

Advantages of IPOs

Investing in IPOs has its advantages. Below are some of the main benefits:

1. Wealth Creation

When a company performs well, its stock price increases, allowing investors to sell shares at a higher price than they bought them for. For instance, investors who bought shares of the tech company Infosys during its IPO saw tremendous returns over time.

2. Transparency

Public companies are legally required to disclose financial information, giving you a clearer picture of their business model and future prospects. This allows investors to make more informed decisions.

3. Liquidity

Once an IPO is complete, the shares can be traded on the stock market. This gives investors the flexibility to buy or sell their shares whenever they need money.

4. Exclusive Opportunities

Some IPOs set aside shares specifically for retail investors. This makes it easier for small investors to take part in the IPO process, giving them a chance to invest in companies at an early stage.

5. Potential for Growth

Many companies use the funds raised in their IPO to invest in expanding their business, entering new markets, or developing new products. This can lead to business growth and, in turn, increased value for shareholders.

Disadvantages of IPOs

While IPOs can be exciting, there are also some risks. Here are a few things to consider:

1. High Risk

Not all IPOs are successful. Some companies may struggle after going public, and the stock price could drop. For example, the stock of some companies has fallen after an IPO due to poor market response or management issues.

2. Limited Information

Even though a company provides detailed disclosures in its IPO prospectus, predicting the future performance of a company can still be tricky. Sometimes, companies might not be entirely transparent about their financial health.

3. Volatility

IPO stocks can be very volatile in the initial days after they are listed. The price can change significantly, which means you could make a profit or a loss depending on market conditions.

4. Overvaluation

Sometimes, IPOs are priced too high. This means the shares might not be worth what investors initially paid for them. It’s important to research and evaluate whether the price is justified by the company’s financials and prospects.

5. Market Timing

Timing is everything when it comes to IPOs. A company might be offering its shares during an unfavorable market condition, which can affect the stock’s performance.

Reasons Why Companies Do an IPO

Companies decide to go public for several reasons, including the following:

1. Raise Capital

The most common reason for an IPO is to raise money. Companies need funds to expand, invest in new projects, or pay off debts.

2. Increase Visibility

Becoming a public company boosts the company’s profile. It also provides more credibility in the eyes of potential customers, investors, and partners.

3. Provide Exit for Early Investors

Founders or early investors may use the IPO as a way to sell their shares and realize profits. It gives them an opportunity to cash out.

4. Expand Business

The money raised from an IPO is often used to fund business growth, enter new markets, or improve infrastructure.

5. Attract Talent

Public companies can offer stock options to employees, making them an attractive employer for skilled talent.

6. Debt Reduction

The company may use the funds raised to pay off outstanding loans or reduce its debt burden.

How an IPO Works

Here’s a simple step-by-step explanation of how an IPO process works:

1. Decision to Go Public

The company decides it wants to raise capital by going public. It hires experts like investment banks, lawyers, and accountants to help manage the IPO process.

2. Regulatory Approval

Before going public, the company must get approval from the Securities and Exchange Board of India (SEBI). They submit a detailed document, known as a prospectus, that provides financial information and explains why they are going public.

3. Pricing

Investment bankers help the company decide on the IPO price. This is the price at which the shares will be offered to the public.

4. Marketing

The company conducts roadshows and marketing campaigns to create interest in its IPO. They meet with potential investors and explain why their business is a good investment.

5. Application

Investors can apply for the IPO by filling out forms through their banks or brokers. This is done within a specified time period.

6. Allotment

Shares are allotted based on demand. If there are more applicants than shares available, a lottery system is used to ensure fairness in allotment.

7. Listing

After the IPO, the shares are listed on the stock exchange, where they can be freely traded.

Types of IPOs

There are different types of IPOs. Below are the most common ones:

1. Fixed Price IPO

In a fixed price IPO, the company sets a specific price for its shares. Investors apply at that price, and the shares are allocated accordingly.

2. Book-Building IPO

In a book-building IPO, the company provides a price range, and investors submit bids within that range. The final price is determined based on the demand for the shares.

3. Fresh Issue

This type of IPO involves the company issuing new shares to raise funds.

4. Offer for Sale (OFS)

In this case, existing shareholders, such as company founders or private equity investors, sell their shares to the public.

Terms Associated with IPO

To help you understand IPOs better, here are some key terms related to the IPO process:

1. Bid

A bid is the offer made by an investor to buy shares at a specific price.

2. Cut-Off Price

The cut-off price is the price decided by the company based on demand. This price is used for retail investors.

3. Lot Size

Lot size refers to the minimum number of shares an investor must buy in the IPO. For example, the lot size may be 10 shares, meaning you need to buy at least 10 shares.

4. ASBA

ASBA (Application Supported by Blocked Amount) is a process where the investor’s funds are blocked in their account until the shares are allotted.

5. BRLM

The Book Running Lead Manager (BRLM) is the entity responsible for managing the IPO process.

How to Get IPOs

1. Open a Demat and Trading Account

To participate in an IPO, you need a Demat and trading account to hold and trade shares.

2. Check IPO Announcements

Keep track of upcoming IPOs on financial websites and news platforms. Many brokers also provide alerts for new IPO offerings.

3. Apply Through ASBA

You can apply for IPOs using your bank’s internet banking or through your broker’s platform.

4. Monitor Allotment Status

Once the IPO is closed, monitor whether you have been allotted shares. You can check the allotment status through the bank or broker’s portal.

5. Start Trading

After the IPO is listed, you can buy or sell the shares on the stock exchange.

FAQs