What is an IPO (Initial Public Offering)?

In finance, few events capture the attention of the media, investors, and the general public quite like an Initial Public Offering (IPO). Often seen as a rite of passage for companies, IPOs signal the transition from a private entity to one publicly traded on the stock market. But what exactly is an IPO? Why do companies opt for them? And how can potential investors navigate this complex yet rewarding landscape?

The answers to these questions and more lie ahead. This guide aims to demystify the concept of Initial Public Offering, shedding light on their inner workings and other detailed aspects.

What is an IPO in the Stock Market?

When delving into the stock market, one term that often emerges is the Initial Public Offering or IPO. Within the framework of the Indian stock market, an Initial Public Offering represents the avenue through which company shares are made available to the general public, institutional investors, and other market participants for the first time.

It marks the company’s debut on the stock exchange, and its shares can be bought and sold by investors. The process commences with the company filing a Draft Red Herring Prospectus (DRHP) with the Securities and Exchange Board of India (SEBI) for approval.

Once sanctioned, the shares are priced, and that is opened for subscription. Investors can bid for these shares, and once the IPO closes, shares are allocated based on demand and other criteria. Subsequently, the company is listed on the stock exchange, and its shares commence trading.

An Initial Public Offering signifies a significant milestone for the company and presents a potential investment opportunity for individuals, enabling them to own a fraction of the firm and partake in its future growth and profitability.

How Do IPOs Work?

In the Indian financial market, Initial Public Offering is a significant mechanism for companies to raise capital.

But how exactly do they function?

1. The decision to Go Public

   Initially, a company’s board deliberates and decides to go public. This decision is often influenced by the need to raise capital for expansion, pay off debts, or facilitate liquidity for early investors.

2. Appointment of Intermediaries

   Once the decision is cemented, the company appoints a set of intermediaries, such as investment banks, to assist with the IPO process. These banks play a role in underwriting the Initial Public Offering and advising the company on its valuation and share pricing.

3. Drafting the Prospectus

   With the help of its intermediaries, the company drafts a detailed document known as the ‘Red Herring Prospectus’. This contains essential information about the company, its financial health, management, and the purpose of the Initial Public Offering.

4. Regulatory Approval

   The draft prospectus is then submitted to the Securities and Exchange Board of India (SEBI). SEBI’s role is to ensure that all disclosures are adequate and in line with the regulatory framework.

5. Pricing and Offer Date

   Once the prospectus is approved, the company, along with its bankers, decides the price range for its shares and sets a date for the IPO to open for subscription.

6. Subscription

   During the subscription period, investors bid for the company’s shares. Depending on demand, shares may be oversubscribed (demand exceeds supply) or undersubscribed (supply exceeds demand).

7. Allotment

   After the closure of the subscription period, shares are allocated to investors. Priority might be given to institutional investors, but retail investors also receive a fixed quota.

8. Listing

   Once the allotment process concludes, the company gets listed on the stock exchange, and its shares commence trading. This marks the company’s transition from a private entity to a publicly traded one.

Types of IPO

IPOs can be categorised based on the nature of the offering and the method of issuing shares. Here’s a breakdown:

Fresh Issue

• Here, a company issues new shares to the public, increasing its share capital.

• The funds raised are used for the company’s various needs, such as expansion, debt repayment, or acquisitions.

Offer for Sale (OFS)

• In an OFS, existing shareholders (like promoters or private equity investors) sell a portion or all of their holdings.

• The company doesn’t receive any funds from this offering; the proceeds go directly to the selling shareholders.

Fixed Price Issue

• The company predetermines the share price.

• Investors know the share price in advance and decide whether to participate in the Initial Public Offering at that fixed price.

Book Building Issue

• Here, a price range is provided, and investors bid within that range.

• Based on the bids received, the final issue price is determined.

• This method offers a more dynamic pricing mechanism, reflecting real-time demand for the company’s shares.

Understanding the types of IPO equips investors with the knowledge to make informed decisions, ensuring they select the best fit for their investment portfolio.

History of IPOs

The genesis of Initial Public Offerings (IPOs) in the Indian financial market dates back to the 19th century and is closely linked with the establishment of stock exchanges in the country.

The Bombay Stock Exchange (BSE), established in 1875, provided a platform for companies to raise capital from the public. However, in the post-independence era, especially during the 1980s and 1990s, IPOs began to gain notable traction.

This period witnessed a liberalisation of the Indian economy, paving the way for private enterprises to flourish. The buoyant economic conditions coupled with regulatory reforms catalysed the growth of IPOs.

The creation of the Securities and Exchange Board of India (SEBI) in 1992 was a turning point, introducing stringent regulations and transparency to the IPO process. These reforms bolstered investor confidence and attracted many domestic and international companies to list on Indian bourses.

Over the years, Initial Public Offering have evolved, reflecting the dynamism of the Indian economy, and have become a prominent feature of the country’s capital market narrative.

How to Apply For an IPO?

Applying for an Initial Public Offering in the Indian financial market, while seemingly intricate, is a straightforward process when approached methodically.

1. Demat Account

   First and foremost, ensure you have a Demat and trading account. This electronic account will hold the shares allocated to you post the IPO.

2. Check IPO Announcements

   Regularly monitor stock exchange websites, financial news portals, or your brokerage platform for upcoming IPO announcements.

3. Study the Red Herring Prospectus

   Every company launching an IPO publishes a draft red herring prospectus containing vital information about the company’s financials, management, and objectives of the Initial Public Offering. It’s prudent to peruse this document to make an informed decision.

4. Apply via ASBA

   Application Supported by Blocked Amount (ASBA) is a mandatory payment method. The application amount remains blocked in the bank account until the share allotment. You can apply directly via the bank’s portal if you have online banking.

5. Choose Investor Category

   Investors are categorised as Retail Individual Investors (RIIs), Non-Institutional Investors (NIIs), or Qualified Institutional Buyers (QIBs). Select the appropriate category when applying.

6. Bid for Shares

   Decide on the number of shares you wish to buy and place your bid. Some IPOs have a book-building process where you can bid within a price range.

7. Wait for Allotment

   The allotment process begins after the subscription period ends. Depending on the oversubscription and category, you may receive the full, partial, or no allotment of shares.

8. Check Demat Account

   If allotted, shares will be credited to your Demat account, after which they can be traded on stock exchanges.

By following these steps, investors can participate in the growth journey of companies entering the public domain.

Terms Associated With an IPO You Must Know

1. Initial Public Offering (IPO)

The process where a company offers its shares to the public for the first time to raise capital and become a publicly traded entity.

2. Prospectus

A legal document that provides detailed information about the company, its financials, business operations, and risks, which potential investors review before deciding to invest in the IPO.

3. Underwriting

The process where investment banks or underwriters guarantee the sale of shares in an Initial Public Offering and assume the risk of any unsold shares.

4. Book Building

A method used to determine the IPO price by collecting bids from potential investors and setting the final price based on demand.

5. Allotment

The process of assigning shares to investors who have applied for them during the IPO.

6. Listing

The point at which the shares of the company become tradable on a stock exchange.

7. Lock-up Period

A predetermined period after the Initial Public Offering during which insiders and major shareholders are restricted from selling their shares.

8. Oversubscription

When the demand for shares in an IPO exceeds the number of shares available, resulting in a higher number of applications than shares.

9. Green Shoe Option

An option that allows underwriters to sell additional shares to meet excess demand in case of oversubscription.

10. Stabilisation Period

A period after the Initial Public Offering where underwriters may buy and sell shares to prevent price volatility and ensure a smooth market debut.

Why Does a Company Offer an IPO?

Debt Repayment

Companies often use IPO proceeds to repay their debts, strengthening their balance sheets and reducing interest costs.

Employee Incentives

An IPO provides an opportunity for the company to offer stock options or equity-based compensation to its employees. This can serve as a valuable incentive to attract and retain top talent.

Liquidity for Existing Shareholders

Early investors, founders, or employees can sell their shares in the public market, realising their investments.

Strategic Acquisitions

With the funds from an Initial Public Offering, companies can acquire other businesses, leading to diversification and bolstered market presence.

By offering an IPO, a company achieves immediate financial objectives. It lays the foundation for sustained growth and increased stakeholder confidence in the future.

Advantages & Disadvantages of IPO

Advantages of IPO

Raising Capital

One of the primary reasons companies opt for an IPO is the substantial capital it can generate. This capital infusion can be pivotal for funding growth, expansions, and R&D efforts.

Company Valuation

Public companies often enjoy higher valuations compared to their private counterparts. An Initial Public Offering can boost a company’s worth, accurately reflecting its market value.

Enhanced Company Profile

Being listed on a stock exchange can significantly amplify a company’s visibility and brand recognition. This can be beneficial in attracting clients, striking better deals with suppliers, and recruiting top talent.

Share Liquidity

Once a company is publicly listed, its shares can be traded freely in the stock market. This provides liquidity for shareholders and allows them to buy or sell shares based on market dynamics.

Mergers & Acquisitions

With publicly traded shares, a company can use its stock as a form of currency for mergers or acquisitions, enabling more flexible deal structures.

Employee Benefits

Companies can offer stock options or employee stock ownership plans (ESOPs) as a compensation package, making them more appealing to potential hires.

Disadvantages of IPO

Costly Process

Going public is an expensive endeavour. The process can strain a company’s finances, from underwriting fees to legal and regulatory charges.

Time-Consuming

Bringing an IPO is not an overnight process. It demands meticulous planning, preparation, and adherence to regulatory guidelines, making it time-consuming.

Loss of Control

By issuing shares to the public, company founders and early stakeholders might see their ownership percentage diminish, leading to a potential loss of control in decision-making.

Increased Scrutiny

Public companies are under the constant scrutiny of analysts, shareholders, and regulatory bodies. They must disclose financials and other significant events, which might not always be in their best interest.

Pressure for Short-term Performance

Public companies are often under pressure to meet quarterly earnings expectations. This might compel them to focus on short-term gains at the expense of long-term strategies.

Risk of Undervaluation

If the market conditions are not favourable at the time of the Initial Public Offering, there’s a risk that the company might be undervalued, potentially leaving money on the table.

For investors, understanding these advantages and disadvantages can offer insights into the company’s future prospects and ability to navigate the complexities of the public market.

Should You Invest in an IPO?

Investing in an Initial Public Offering (IPO) in the Indian financial market is a decision that balances excitement and caution. On the one hand, IPOs present an opportunity to invest in a company at its initial stage in the public market, potentially reaping significant returns if its future trajectory is upward.

Stories of stocks listing at a premium and investors making quick gains often entice many to jump onto the IPO bandwagon. But, Initial Public Offering comes with inherent risks. Not every company that goes public turns out to be a success story. Market volatility, overvaluation, or even the company’s own unproven track record in the public domain can lead to disappointing performances.

Like any investment decision, investing in an Initial Public Offering requires thorough research, an understanding of the company’s fundamentals, and a clear assessment of one’s own risk appetite. While the allure of immediate gains might be tempting, a pragmatic and well-informed approach is paramount.

Things to Know Before Investing in IPOs

Before investing in an IPO, here are some pivotal considerations:

Company’s Fundamentals

Scrutinise the company’s balance sheets, profit and loss statements, and growth prospects.

Purpose of the IPO

Understand why the company is going public. Is it to fund expansion, repay debts, or provide an exit for early investors.

Red Herring Prospectus

This document, issued by the company, provides detailed insights into its operations, management, financial health, and risks involved.

Management Quality

A strong, experienced management team can indicate the company’s future prospects.

Market Sentiment

While not always a foolproof metric, understanding the current market sentiment can provide insights into the potential listing performance of the IPO.

While Initial Public Offering can be enticing investment avenues, they necessitate a well-rounded analysis. A blend of due diligence and market insight can steer one towards making informed decisions.