What is IPO: Full Form, Definition, Types, and Benefits

An Initial Public Offering (IPO) is the process by which a private company offers its shares to the public for the first time and transition into a publicly traded entity. This significant milestone helps the company raise capital by selling a portion of ownership to individual and institutional investors on stock exchanges. IPOs are popular among investors as they have the potential to offer high returns, especially when investing in established and high-growth companies. 

In this blog, we will give you information about the IPO process, its types, timeline, advantages and how to invest in an IPO. Understanding the IPOs, their types and their benefits can aid investors in making better investment decisions. 

What is an IPO?

An Initial Public Offering (IPO) is an event in which a company offers its shares to the public for the first time, which are then publicly traded on a stock exchange. This process allows companies to raise capital for growth, expansion, and innovation by offering ownership stakes to a wide range of investors. 

Investors view IPOs as an opportunity to invest in the early stages of companies with a promising future, though they carry certain risks. IPOs are crucial for both businesses and investors in the financial market. 

Types of IPO

IPOs can be of two types, each serving different purposes in the financial market and attracting diverse investor interests. Understanding these types helps with strategic IPO investment. The two primary types of IPOs are:

1. Fixed Price IPO: In a Fixed Price IPO, the company determines a fixed price, and investors agree to buy shares at this price. However, the demand is only known after the IPO closes.

2. Book-Building IPO: In a Book-Building IPO, the company sets a price range rather than a fixed price and allows the investors to bid within that range. The final price is then determined based on demand. This method provides flexibility as prices can adjust based on demand.

Terms Associated with IPOs

Investors must understand several key terms associated with an IPO and understand the process better. Here’s a look at some important terms associated with IPOs:

• IPO Price: The IPO price is the initial price set for the shares offered to the public. In a Fixed-price IPO, the price is determined beforehand, while in book-building IPOs, investors bid within a range, and the final price is set based on demand.

• Prospectus: It is a vital document issued by the company, which provides the potential investors with the objective of issuing an IPO and the company’s financials, business model, and associated risks. It is a comprehensive guide that helps investors make better investment decisions.

• Underwriter: Underwriters are investment banks or financial institutions that assist the company in preparing for the IPO. They help in the preparation of the documents, pricing, marketing, and handling the regulatory aspects of the IPO.

• Lock-Up Period: After an IPO, there’s often a lock-up period during which company insiders like executives, and early investors cannot sell their shares. This period helps stabilize the stock price post-listing.

• Oversubscription: When demand for an IPO exceeds the shares offered, it is termed an oversubscription. Oversubscribed IPOs indicate high interest from investors, potentially leading to a price surge on the listing day.

• Online IPO Application: With the rise of digital platforms, online IPO applications allow investors to participate in IPOs easily. This accessibility has popularized IPO investment among retail investors, allowing them to participate in the initial public offering directly from trading accounts.

• Listing Day: This is the first trading day of the newly issued shares on a stock exchange. Prices often fluctuate significantly due to high demand, especially for popular IPOs.

Understanding these IPO-related terms enables investors to navigate the IPO process confidently, helping them make strategic investments in the share market. 

How does an Initial Public Offering (IPO) work?

An Initial Public Offering (IPO) is an event when a private company offers its shares to the public for the first time to raise capital. IPO stands for Initial Public Offering and marks the company’s entry into public trading on stock exchanges. To initiate an IPO, a company must follow the following steps: 

1. Hire an Underwriter: The first step in launching an IPO is to hire a Merchant Banker (Lead Manager) for underwriting services. These banks help determine the pricing, offer structure, etc., and ensure that the company complies with regulatory requirements. 

2. Submit Documents: The company and the merchant banker work together to prepare a draft prospectus (DRHP), which is submitted to SEBI for review. The prospectus contains financials, risks and other important details regarding the offer and the company. 
3. SEBI Approval and IPO Application: SEBI verifies the details mentioned in the DRHP and approves it. After regulatory approval, an IPO application is submitted to the stock exchange.
4. Price Determination: A pricing method is determined by the issuer and merchant banker. They can select either fixed-price issues or book-building issues. In a Book Building, IPO and investors bid within a specified price range, while in a Fixed-price IPO, shares are offered at a set price.
5. RHP Submission: An RHP is an updated version of DRHP, which contains the latest information about the company. RHP is submitted to the exchange.
6. Marketing: Merchant bankers appoint PR & advertising agencies to make the IPO popular. The main objective of marketing campaigns is to generate interest among the general public.
7. IPO opens to Anchor Investors: An anchor investor is a qualified institutional buyer (QIB) and submits a bid of at least INR 10 crore.
8. IPO opens to the Public: Investors apply for IPO through their brokers or banks. 
9. IPO shares Allotment: Shares are allotted to investors through a lottery in most cases. Exchange coordinates with banks to confirm the bank accounts and demat accounts of IPO applicants. Upon successful verification, the investment amount is deducted from the investor’s bank account and shares are credited to the investor’s demat account.
10. Listing Date: Shares offered in an IPO are traded on this day. Before trading, a pre-open session is organized in which investors can place orders. The orders can be entered, modified or canceled from 9:00 am to 9:45 am. From 9:45 am to 9:55 am, the orders are matched, and normal trading begins at 10:00 am on the listing date. 

What is the IPO Timeline?

The IPO timeline is the stages a private company undergoes to go public and list its shares on a stock exchange. It typically begins with planning and due diligence, during which the company assesses its readiness, hires underwriters, and conducts financial audits. This is followed by filing the regulatory documents, such as the prospectus with the regulatory bodies and exchange, providing details of the IPO, including the risks, financial statement,s and objectives of issuing an IPO.

Next, through IPO roadshow and marketing, the issuer and merchant bankers introduce the IPO to potential investors, which helps them analyze the demand for the IPO and set an appropriate price range. Once the price is finalized, the shares are offered to institutional and retail investors.

Finally, on the IPO listing day, the shares are publicly traded on the stock exchange, which marks the completion of the IPO process. This entire timeline can take several months, depending on the company’s preparedness, regulatory requirements, and market conditions.

Benefits of Investing in an IPO

Investing in an IPO or Initial Public Offering presents a unique opportunity for investors to become part of a company’s growth journey. Some of the key benefits are:

1. Popular IPOs generally perform well on the listing day, and investors can sell their shares to realize significant returns in a short span of time.

2. As the company expands and grows using the capital raised through IPO, its stock gains value over time. Investors can participate in the IPO and hold onto shares for capital appreciation.
3. IPO investments also provide portfolio diversification and offering exposure to new industries or innovative companies that can balance other investment risks. 
4. Companies launching an IPO are required to disclose their financials and growth plans in their prospectus, which gives the investors valuable insights.

Advantages and Disadvantages of IPOs

The advantages and disadvantages of IPOs for companies and investors are mentioned below.

Advantages

For companies, IPOs provide access to substantial capital for growth, expansion or debt reduction. Public listing also enhances credibility and visibility, which improves the company’s profile in the market. For investors, IPOs provide an opportunity to invest early in a company with growth potential and often leads to high returns if the stock performs well. Liquidity improves as shares can be easily traded on public exchanges.

Disadvantages

However, IPOs also come with challenges. Companies going public are subject to increased regulatory scrutiny as they are required to disclose financial, operational details, which can reduce privacy. Additionally, market fluctuations may lead to volatility in stock prices, impacting both the company’s valuation and investor confidence. For investors, IPOs carry risks as some companies may struggle post-IPO and potentially resulting in losses.

Types of Investors in IPO

There are three main types of investors in an IPO (Initial Public Offering): Retail Investors, Qualified Institutional Buyers (QIBs), and High Net Worth Individuals (HNIs). Each plays a unique role in the IPO process.

• Retail Investors: These are individual investors applying for smaller lots, usually through online IPO applications. They make up a significant portion of IPO participants and are often allotted a reserved quota in IPOs to encourage public participation.

• Qualified Institutional Buyers (QIBs): QIBs include entities like mutual funds, banks, and insurance companies. They have vast resources and expertise, making them crucial in determining the demand and pricing of an IPO. QIBs usually receive a reserved portion of shares in large IPOs.

• Non-Institutional Investors: Non-institutional investors or HNIs invest larger sums than retail investors but are not institutions. 

How to check for upcoming IPOs?

To check for upcoming IPOs, investors can explore various reliable sources. Stock exchange websites like the NSE and BSE in India provide updated IPO calendars and announcements. 

Additionally, brokerage platforms often list upcoming IPOs and offering the detailed information and online IPO application options. Some financial applications and investment portals include IPO tracking tools with notifications for new listings. 

How to Invest in an IPO?

Investing in an IPO involves several straightforward steps. First, upcoming IPOs should be identified through stock exchange websites or financial news platforms to identify investment opportunities. Next, ensure you have a Demat account set up with a depository participant (DP) to apply for an IPO.

Once you have identified an IPO, submit your IPO application through your DP platform. Track the allotment status as not all applicants may be allotted shares due to high demand. If the shares are allotted, monitor the stock performance post-listing. 

Conclusion

In conclusion, investing in an IPO can be a rewarding opportunity for both individual and institutional investors. By researching upcoming IPOs and using online platforms, investors can own shares of companies at their early stages of growth. Understanding the mechanics of the IPO process is crucial for making informed investment decisions. While the potential for high returns exists, it is important to consider the associated risks and market volatility.

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