What is Initial Public Offerings (IPO)

IPO: Learn how companies enter the stock market, inviting the public to buy its shares for the first time.
What is Initial Public Offerings (IPO)
3 mins
02 September 2023

An Initial Public Offering (IPO) is a significant milestone in a company's journey from being privately owned to becoming a publicly traded entity. It is an exciting opportunity for investors to participate in a company's growth story from its early stages. In this comprehensive guide, we will explore what an IPO is, how it works, the step-by-step IPO process, and everything you need to know about investing in IPOs in India.

What is an IPO?

An IPO, or Initial Public Offering, is the process by which a privately held company makes its shares available to the general public for the first time. It transitions from a privately-owned entity to a publicly traded company, allowing individuals and institutional investors to purchase its shares.

An IPO is an important step in the growth of a business. It provides a company access to funds through the public capital market.

Types of IPO

There are two common types of IPO:

  1. Fixed price offering:
    A fixed price issue is a straightforward approach to setting the price of shares before they are offered to the market. This method involves the company determining a fixed price per share, which remains constant throughout the IPO process. To establish this price, the company collaborates with financial experts like merchant bankers and underwriters.
    Fixed-price offerings have traditionally been favored by Indian businesses for capital raising. Investors appreciate this type of IPO due to its transparency. They have clarity on the exact price per share they will pay, providing reassurance to those who prioritize predictability in their investments.
  2. Book building offering:
    In contrast to fixed price issues, book building offers a more dynamic approach to determining share prices. In this method, the company sets a price range or band within which investors can bid for shares. This range includes a lower limit known as the 'floor price' and an upper limit called the 'cap price.'
    During the bidding phase, investors submit bids within this specified range, indicating the quantity they wish to purchase and the price they are willing to pay. This mechanism allows the company to gauge investor interest and finalize the share price based on the demand received.
    Book-building issues are gaining popularity in India due to their flexibility and ability to accurately reflect market demand. It empowers investors to influence the final price based on their willingness to pay, thus aligning the pricing with market dynamics effectively.

How an initial public offering (IPO) works

In an IPO, a company decides to raise capital by issuing shares of its stock to the public. Here's how the process typically works:

1. Preparation phase:

  • A company decides to go public and appoints investment banks as underwriters.
  • Extensive due diligence, including financial audits and legal compliance checks, is conducted.

2. DRHP filing:

The company files a Draft Red Herring Prospectus (DRHP) with the Securities and Exchange Board of India.

3. Select the stock exchange:

The next step would be to decide the exchange where the company would list its shares should be made, followed by an application to the selected exchange.

4. Roadshow:

The company, along with underwriters, conducts a roadshow to promote the IPO to potential investors.

5. Pricing:

  • Based on investor demand and market conditions, the offering price is determined.
  • The final prospectus, known as the Red Herring Prospectus (RHP), is issued with the offer price range.

6. Allocation:

  • Shares are allocated to various investor categories, including Qualified Institutional Buyers (QIBs), Non-Institutional Investors, and Retail Individual Investors.
  • Bidders can apply for shares within the specified price range.

7. Listing:

The company's shares are listed on stock exchanges like NSE and BSE.

8. Trading commences:

  • On the IPO day, the shares become available for trading in the secondary market.
  • Investors can buy and sell shares at market prices.

9. Lock-up period:

Promoters and certain shareholders are often subject to lock-up periods during which they cannot sell their shares.

10. Post-IPO reporting:

The company is required to provide regular financial and operational updates to the stock exchanges and investors.

11. Stabilisation period:

In some cases, underwriters may engage in stabilisation activities to support the stock's price during the early trading period.

The IPO process in India involves rigorous regulatory compliance and thorough investor scrutiny to ensure transparency and fairness in the capital markets.

What is the IPO timeline?

  1. Open/close date:
    These are the dates when the IPO bidding process is open. Potential investors can apply or bid for shares during this period. It marks the window for submitting IPO applications.
  2. Allotment date:
    On the allotment date, the registrar of the IPO announces the allotment status to the public. It reveals who has been allocated shares and in what quantity.
  3. Refund date:
    The refund date is when the application amount, which is temporarily frozen, becomes eligible for refund to those who did not receive IPO allotments. It marks the date when the refund process begins.
  4. Credit to Demat account date:
    This date varies depending on the company but is when investors receive the credited IPO shares in their Demat accounts. This happens before the official listing date of the shares.
  5. Listing date (IPO listing):
    The listing date is when the company's shares are officially listed on the stock exchanges, making them available for trading in the secondary market. It is the point at which the IPO shares become publicly tradable.

Pros and cons of investing in IPO

Investing in an IPO offers early access to promising companies and the potential for high returns. However, it comes with risks such as volatility, limited historical information, and susceptibility to market conditions.

Before investing in an IPO, it is important to understand the potential advantages and disadvantages that come with it.

Pros of investing in an IPO:

  1. Early investment opportunity: IPOs provide an opportunity to invest in a company during its early stages of going public, potentially benefiting from long-term growth.
  2. Potential for high returns: Successful IPOs can offer significant capital appreciation as the company's value may increase after listing.
  3. Access to promising companies: IPOs often involve innovative or promising companies that were previously private, allowing investors to be part of their growth story.
  4. Liquidity for founders and early investors: Existing shareholders, including founders and early investors, can monetise their investments by selling shares in the IPO.
  5. Market visibility: Going public can increase a company's visibility and credibility, which can positively impact its business relationships and growth prospects.

Cons of investing in an IPO:

  1. High risk: IPOs are inherently risky, as newly public companies may lack a track record of profitability and face uncertainties in the market.
  2. Volatility: Share prices of IPOs can be highly volatile during the initial trading period, making it challenging to predict short-term price movements.
  3. Limited historical information: Investors have limited access to historical financial data and performance metrics, making it challenging to conduct comprehensive due diligence.
  4. Potential for overvaluation: Some IPOs may be overvalued, leading to price corrections after the initial hype subsides.
  5. Lock-up periods: Promoters and early investors are often subject to lock-up periods, during which they cannot sell their shares, potentially affecting the stock's supply and demand dynamics.
  6. Market conditions: IPO success can be influenced by broader market conditions, and adverse market conditions may lead to postponed or cancelled IPOs.

Investing in an IPO requires careful consideration of these factors, as well as thorough research and risk assessment. While the potential for high returns can be enticing, it's important to balance the rewards with the associated risks.

Why does a company offer an IPO?

Companies offer IPOs for several reasons:

  1. Capital infusion: IPOs raise capital, which can be used for business expansion, debt reduction, or other corporate purposes.
  2. Liquidity for investors: Existing shareholders, including founders and early investors, can monetise their investments by selling shares in the IPO.
  3. Enhanced visibility: Going public can increase a company's visibility and credibility in the market.

How to invest in an IPO?

Investing in an IPO typically involves the following steps:

  • Evaluate the IPO prospectus
    Study the prospectus, which contains essential information about the company's operations, risks, and financials. It provides insights into the company's potential and helps you make an informed investment decision.
  • Open a Demat account
    To participate in the Tata Technologies IPO, investors should have a Demat account. Bajaj Financial Securities Limited stands as a reliable choice for investors seeking to open a Demat account with abundant features and complete safety.
  • Apply for the IPO
    Once you have a Demat account and trading account, you can apply for the IPO through the broker's platform. You will need to provide the necessary details and specify the number of shares you want to subscribe to.

Terms associated with IPO

Underwriter

Third parties such as a banker, financial institution, or a broker hired by the company to assist with underwriting the stocks.

Fixed price IPO

Fixed Price IPO refers to a predetermined issue price set by companies for the initial sale of their shares.

DRHP

DRHP stands for Draft Red Herring Prospectus. It is a preliminary document filed by a company to the SEBI when it is planning to issue an IPO.

Book building

Book building refers to the process where underwriters or merchant bankers determine the price at which IPOs will be offered.


Things to remember while investing in an IPO

When considering investing in an IPO, it's essential to keep the following factors in mind:

  1. Research the company:
    Thoroughly study the company's background, financial health, and future prospects before making an investment in the IPO. Understanding the business and its potential for growth is crucial.
  2. IPO locking period:
    Take note of the IPO locking period. This period restricts your ability to sell or trade the IPO shares immediately after the initial investment. Be aware of the duration of this lock-in period.
  3. Investment strategy:
    Always have a well-defined investment strategy in place before participating in any IPO. Determine your financial goals, risk tolerance, and how the IPO fits into your overall portfolio. Planning your investment approach is essential for making informed decisions and managing your investment effectively.

Conclusion

Investing in an IPO can be an exciting opportunity to participate in the growth of a company from its early stages. However, it comes with risks, and thorough research and consideration of various factors are essential. By understanding the IPO process, evaluating companies, and using reliable platforms like Bajaj Financial Securities Limited, you can make informed investment decisions in the dynamic world of IPOs.

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Investments in the securities market are subject to market risk, read all related documents carefully before investing.

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This content is for educational purpose only.

Investment in the securities involves risks, investor should consult his own advisors/consultant to determine the merits and risks of investment.

Frequently asked questions

Is IPO profitable?

IPOs offer an opportunity to invest in a company at its early stages and potentially see significant returns in the future. However, investing in IPOs can be risky and volatile, and it is important to do proper research and understand the risks involved before investing.

How to sell IPO shares?

Once you have been allocated IPO shares, they are stored in your Demat Account. You can sell them at any time using your Demat and trading account. However, selling IPO shares requires strategic thinking and planning. You must consider factors such as risk, tax implications, emotional wellbeing, restrictions to sell, and suggestions from brokers before selling.

Is IPO a stock or a share?

IPO is not a stock or a share, but a process by which a company becomes a public company by offering its shares for public purchase in a new stock issuance.

How is an IPO priced?

The price of an IPO is determined by the company and its advisors, who set an initial price for the offering based on market demand and supply.

How is IPO profit calculated?

The profit from an IPO depends on the difference between the issue price and the listing price of the shares. The profit can be calculated by subtracting the issue price from the listing price and multiplying the result by the number of shares allotted.

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