What Is an IPO? Meaning, Process, Types & Why It Matters to Investors

An Initial Public Offering (IPO) is the mechanism that allows companies to get listed on stock exchanges and raise fresh capital from the public. These funds can allow companies to invest in their growth, expansion, or debt repayment.

For you, IPOs are a way to join in the company's growth journey from the very start. They also, however, involve risks and complications. To ensure investor interest, the Securities and Exchange Board of India (SEBI) regulates IPOs and other investments.

As per the Initial Public Offering definition, it is a process through which a private company offers its shares to the public for the first time. It involves listing the company shares on a stock exchange, such as the National Stock Exchange (NSE) or Bombay Stock Exchange (BSE). 

Initially, the company's shares may be privately held by founders, early investors, and employees. The IPO converts the company into a publicly traded entity. IPOs allow a company to raise capital by selling new shares. Post-IPO, you can trade shares in the secondary market.

Companies decide to launch an IPO for several reasons, which can range from fundraising to enhancing visibility. Some of them are listed below. 

• Raising Capital: The primary reason is to raise funds from a large pool from investors to enables business growth or diversification. 

• Enhancing Visibility: Public listing enhances brand recognition and credibility among customers, partners, and investors. 

• Regulatory Compliance: For companies seeking growth or acquisitions, being public ensures compliance with regulatory processes.

The process of an IPO involves several key steps. These include:

1. Appointment of Merchant Bankers and Underwriters

Companies hire investment banks or merchant bankers to manage the IPO. They assist with regulatory filings, pricing strategy, and marketing the issue to investors. Underwriters agree to purchase unsold shares, minimising risk for the company.

2. Due Diligence and Draft Red Herring Prospectus (DRHP)

The company prepares a detailed document called the DRHP, containing financial statements, business details, risks, and management information. The company then submits the DRHP to SEBI for approval.

3. SEBI’s Observational Period

During this period, the SEBI verifies the application and IPO details. The company's financials and details are analysed for errors, discrepancies, and issues. If all is well, SEBI approves the application and asks the company to set an IPO date. 

4. Listing Application

Simultaneously with the DRHP filing or shortly thereafter, the company applies to the chosen stock exchange (NSE, BSE, or both) for in-principle approval for listing. Final listing approval is granted after the successful completion of the IPO and allotment of shares. 

5. Marketing and Roadshows

Post-approval, merchant bankers and company executives organise roadshows. The aim is to present the company’s business to institutional investors across cities. It helps gauge demand and generate interest. 

6. Pricing and Book-building

There are two methods through which a company determine the IPO price: fixed price and book-building. 

In a book-building IPO, you place bids indicating the quantity and price you are willing to pay. The price band is decided, and the final price is set based on demand. In contrast, a fixed-price IPO sets a predetermined price for shares. 

7. Allotment of Shares and Listing

After the bidding closes, shares are allotted to you. The company’s shares are then listed on stock exchanges, such as the NSE or BSE, allowing trading to commence.

Here is a quick overview of the different types of IPOs in the share market: 

• Fresh Issue

This refers to the creation and issuance of new shares to the public for the first time to raise capital. It dilutes the ownership of existing shareholders because the total number of shares increases.

• Offer For Sale (OFS)

Existing shareholders offer shares for sale to the public without issuing new shares. It provides liquidity to current investors.

The price of an IPO in the share market depends on various factors. Here are some of them.

• Company Valuation: Based on financial performance, growth potential, and industry benchmarks

• Market Conditions: Prevailing market sentiment and economic factors influence pricing

• Investor Demand: Book-building method uses investor bids to guide the final price

• Regulatory Guidelines: SEBI sets rules on minimum pricing and disclosures

• Comparable Companies: Share prices of similar companies in the industry are assessed

• Company Goals: May also depend on objectives, such as valuation optimisation or fundraising
  

Formula to understand issue price setting:

Issue Price = (Company Valuation) / (Total Number of Shares Issued)

IPOs allow investors to participate in a company's transition to the public market. Some benefits of IPOs include: 

• Opportunity to invest early in a company’s growth journey

• Potential for significant capital appreciation

• Access to new and diverse investment opportunities 

• You can trade the shares in the open market, enhancing liquidity and flexibility 

• Cost-effectiveness, as most companies offer shares at a discounted price 

Understanding these factors helps investors make informed decisions aligned with their risk profile.

Familiarising yourself with the essential IPO terms empowers you to make informed decisions. Here are some key terms every investor should know before investing in an IPO:

• Prospectus: Document detailing the IPO, company information, and risk factors

• Issue Price: The price at which shares are offered in the IPO

• Grey Market Premium: Informal premium paid for IPO shares before listing

• Listing: When a company's shares are admitted to be traded in the stock market

• Lock-up Period: Duration during which promoters and initial investors cannot sell shares

SEBI regulates IPOs to promote fair practices and build investor confidence. Some of the key regulations include the following:

• Requires detailed disclosures to ensure transparency

• NSE and BSE oversee the trading post-listing

• Companies must comply with the Companies Act, 2013

Initial Public Offerings are key events that allow companies to access public capital. Alongside, they offer you a route to participate in corporate growth. Understanding what an IPO entails equips you to approach it thoughtfully and invest accordingly. 

While IPOs can provide growth opportunities, awareness of associated risks and regulations helps you navigate them.

This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.