What is an IPO?

The full form of IPO is Initial Public Offering. As per the IPO definition, it is a process when a private company becomes public by selling its shares to the public for the first time. Any institutional investor, high-net-worth individual (HNI), and the public can invest in an IPO. Once the IPO is closed, shares of the company are put on a list and can be traded in the market without any restrictions. An IPO is one of the most critical processes in the evolution of a firm. It enables a corporation to seek investment activity in the share market. This article focuses on explaining all the aspects related to “what is an IPO”, including IPO meaning, its types, benefits, and more.

Key Highlights

• An IPO is a transition of the company from private to public trading, raising capital for the company’s growth, and offering investment opportunities.

• IPOs are of two types: fixed-priced and book-building offerings. Each offers its unique features.

• The IPO mainly deals with the following stages: preparation, filing of DRHP, listing, and trading. In this way, it becomes easier to go public in a very organised manner.

• An IPO investment allows for high returns and buying shares in a wide range of new companies. However, it involves risks like volatility and a lack of historical background.

Understanding IPO

An IPO, or Initial Public Offering, is when a private company sells shares to the public for the first time. This lets people buy shares of the company. Companies offer IPOs to get finances for their business needs. An IPO usually occurs when the company needs to put in capital to ease the trading of the existing assets, in the case of raising capital for growth prospects and more such reasons.

Understanding IPOs is important for both companies and potential investors. The company selects an underwriter that is to assist it in carrying out the IPO. They make a plan on how to execute an IPO by understanding all the details. Once the permission to proceed is granted by the SEBI, a date for the IPO is then fixed and presented to the public.

Types of IPO

Companies employ various IPOs to sell their shares to the general public. Every type comes with its own pricing strategy and method, which investors will choose according to their interests. Understanding these types aids investors in making decisions regarding involvement in an IPO. So, let’s discuss them in brief:

1. Fixed Price Offering 

A fixed-price IPO is when a company announces exactly what price it wants to sell its shares. All investors know this price clearly during an IPO. Once the IPO ends, it’s clear how much demand there is for those shares. If you decide to purchase them as requested, you’ll need to pay the full price.

2. Book Building Offering 

In the case of a book-building IPO, the firm provides a range of prices instead of a fixed amount. This range is defined by investors who preserve their bids until the last proposal is made. Investors need to specify the number of desired shares and the amount available for purchase per share. At the lowest point, there is a floor price, but at a higher level, there is a cap price. The final price for all stocks is determined based on bids collected from different market participants.

Working of Initial Public Offering (IPO)

Understanding IPO process is crucial for investors who want to invest in it. This process consists of several important stages that enable a company to list itself on stock exchanges and release its stock to the general public for the first time. The following breakdown explains how IPO works:

• An IPO is when a company sells its shares to the public for the first time. The company chooses banks to help sell its shares and get its financial statements checked.
• The company files a Draft Red Herring Prospectus (DRHP) with SEBI (Securities Exchange Board of India). It then selects a stock exchange to list its shares.
• The management of the company, along with the underwriting firm, promotes the IPO to potential investors. They offer information regarding the company, the interest in the IPO, and other important details. 
• The final share price is determined by investor demand. This information is included in the Red Herring Prospectus (RHP).
• Shares are allocated among different investor groups. These typically include institutional buyers, non-institutional investors, and retail investors applying within the price range.
• On listing day, the company’s shares begin trading on chosen stock exchanges. Investors can then buy or sell these shares at market prices.
• Some companies may have a lock-up period, preventing them from selling shares to avoid sudden price fluctuations.
• After the IPO, the company must provide regular updates to stock exchanges and investors about its financial performance and business operations.
• Underwriters might engage in price stabilisation activities, buying shares to maintain the stock price during initial trading.

This is how the IPO process allows companies to raise capital for growth. It provides investors, a chance to experience potential gains by offering an opportunity to invest in growing companies early.

Why Does the Company Offer an IPO?

There are several reasons a company offers an IPO. Let’s discuss them in brief: 

• Capital Infusion: An IPO helps a company raise funds, which can be used to expand the business, pay off debts, or for other company needs.
• Liquidity for Investors: Existing shareholders, like founders and early investors, can sell their shares during the IPO to get cash from their investments.
• Enhanced Visibility: Going public makes a company more visible and improves its reputation in the market.

Advantages of Investing in an IPO

IPO offers several notable benefits to the investors. This includes:  

• 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.
• Potential for High Returns: Successful IPOs can offer significant capital appreciation as the company’s value may increase after listing.
• Access to Promising Companies: IPOs often involve innovative or promising companies that were previously private, allowing investors to be part of their growth.
• Liquidity: Existing shareholders, including founders and early investors, can monetise their investments by selling shares in the IPO.
• Market Visibility: Going public can increase a company’s visibility and credibility, which can positively impact its business relationships and growth prospects.

Disadvantages of Investing in an IPO

Along with benefits, IPOs also carry several drawbacks like any other investment option. This includes: 

• High Risk: An IPO is risky because no profit history is available for many privately owned firms that become public.
• Volatility: Share prices in IPOs can fluctuate a lot within the initial months. Hence, it becomes difficult to predict their behaviour in the short run.
• Limited Historical Data: Limited historical financial data and indicators are available for investors of these new companies. Hence, making it difficult for them to do due diligence entirely when investing in these companies.
• Potential for Overvaluation: Prices of some IPOs during initial sale might be very high, causing price corrections later.
• Lock-Up Periods: Often promoters and early investors would be restricted from selling their shares during lock-up periods. Hence, they influence supply and demand patterns on the exchanges.
• Market Conditions: Different aspects of the economy can affect IPO functioning, which would lead to a postponement or cancellation of the process.

How To Check For Upcoming IPO?

It is important to stay updated about the latest IPOs to make an informed decision. So, here are several ways you can check the upcoming IPOs:

• Some stock exchange sites usually have a section set aside for IPOs. Information regarding upcoming IPOs, IPO calendars, and prospectuses can be found under such sections.

• Various sites on the internet offer dependable news under headings like “new IPOs” or “IPO list”.

• Other places where one can find information about upcoming IPOs include website aggregates, official brokers, stock market information websites, and blogs.

What is the IPO Timeline?

To help investors understand how businesses go public, they need to know the key stages involved like the IPO timeline. The following breakdown explains the IPO timeline:

• Open/Close Date: These are the dates when the IPO bidding process is going on. Potential investors can bid or apply for shares in this period. This indicates the IPO application submission period.
• Allotment Date: On the allotment date, the registrar of the IPO announces the allotment status to the public. It shows those who have been allocated shares and in what quantities.
• Refund Date: On this date, the application amount that has been temporarily frozen becomes eligible for refund to those who did not get an allotment from IPO. This marks the initiation of the refund process.
• Credit to Demat Account Date: This might differ based on companies, but it is when investors receive IPO shares in their respective Demat accounts. This occurs before shares are officially listed.
• Listing Date (IPO listing): The listing date is when the company’s shares get officially listed on stock markets, making them tradable in the secondary market. This point indicates the public trading of IPO stocks.

How does IPO Differ from Regular Stock Market Investing?

It is important to understand the differences between an IPO and regular stock market investing because they entail different procedures, individuals, and risks for investors. So, here’s a table that shows the difference between IPO and regular stock:

Terms Associated with IPO

To have an informed understanding of an IPO, one needs to know a few basic terms. In the table below, you will find some commonly used terms.

Conclusion

IPO is one of the critical stages for a private firm as it enters the open market. It helps investors get potential benefits from growing businesses by investing in their IPO. While IPOs provide several opportunities for better gains, they also come with risks. This risk has the potential for overvaluation and the market’s unpredictability. Therefore, knowing “what is IPO definition” and its process eases the decision-making of an investor. There are several important concepts associated with IPOs, such as underwriters, price bands, book building, and flipping, among others. These concepts are important in understanding how IPOs operate.  Overall, IPOs offer the potential to take advantage of opportunities to invest with a properly planned strategy.

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