What is IPO in Share Market?

What is IPO in Share Market?

An initial public offering (IPO) is the process by which a private business goes public by selling stock to the general public. It might be a new, young firm or an established corporation that decides to list on an exchange and therefore become public.

Initially, a private company develops with the support of early investors, founders, and stakeholders. Once the company achieves a specific milestone and the management deems it stable enough to adhere to the regulations set by the Securities and Exchange Board of India (SEBI), expand, and diversify using investor funds, they opt for an Initial Public Offering. This process allows the general public in India to participate by purchasing shares in the company and becoming a part of its journey.

How does an Initial Public Offering Work? 

An IPO is often launched by a corporation to enhance equity capital, generate funds for the future, permit simple asset trading, or monetize current shareholder interests. 

The prospectus contains information regarding the initial sale of shares that may be evaluated by both institutional investors and the general public. Comprehensive information about the prospective offers is provided in the lengthy prospectus. 

Following the IPO announcement, the listed stock is available for trading on the stock market app. The minimum free float requirement for shares is established by the stock exchange both in absolute terms and as a percentage of the entire share capital. 

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Table of Content

  1. How does an Initial Public Offering Work? 
  2. Types of IPOs
  3. Why are IPOs Generated? What is the Need for Launching IPOs? 
  4. Terms Associated with IPOs 
  5. Advantages and Disadvantages of IPOs 
  6. Types of Investors in IPO 
  7. How are IPO Shares Allocated to Each of the Investor Categories? 
  8. How does a Company Benefit from an IPO? 

Types of IPOs

There are two types of IPOs. They rely on the kind of price generation that the business or underwriter is aiming for. These come in two types: Fixed-price offering and Book Building Initial public offering(IPO). 

  • Fixed-Price Offering

    In a fixed-price offering, the business establishes the initial stock price, and investors must pay that specific price per share to acquire the desired quantity of units.

  • Book-Building Initial Public Offering (IPO)

    In a book-building IPO, the company sets a price range for the upcoming IPOs, with the floor price being the lowest and the cap price being the highest. Through a collaborative decision-making process involving underwriters and company investors, the share value is determined based on polls. Once bids are placed, the stocks are allocated to the selected bidders.

Why are IPOs Generated? What is the Need for Launching IPOs? 

A company issues an IPO in the share market for two main reasons: to raise money or give back money to its first supporters or angel investors.

When a company releases an IPO, it allows the public to invest in it. IPOs give the company a bigger pool of potential investors, enabling them to collect more money than they could from private investors.

Another reason for an IPO launch is to reward its first supporters. These supporters can choose to sell their shares in the company and get back some of the money they initially invested.

Terms Associated with IPOs 

Here's a table of terms associated with IPOs:

IssuerThe business offers stocks in an IPO to raise money.
UnderwriterA banker, financial institution, or broker assisting the firm in underwriting the IPO, acting as a middleman between the public and the issuer.
Price BandThe range of lower and higher share prices at which a firm plans to go public.
Issue SizeIn an IPO, the total value is obtained by multiplying the quantity of shares issued by the value of each share.
Under SubscriptionWhen the public shows less interest in the shares than the firm has issued, resulting in an under-subscribed situation.
OversubscriptionA situation where the firm receives more applications for shares than the available quantity, leading to an oversubscribed scenario.
DRHPDraft Red Herring Prospectus - A preliminary registration document for a book-built IPO, created by investment bankers. Contains financial and operational details, along with reasons for fundraising.
RHPRed Herring Prospectus - The preliminary registration document submitted to SEBI for a book-built IPO. It lacks specific details about the quantity of shares and their offered price.

Advantages and Disadvantages of IPOs 

IPOs play a crucial role in generating or raising capital. Furthermore, they bring along some additional advantages and they are listed as below: 

Advantages of IPOs 

Here are a few advantages of IPOs:

  • Capital Raising: A corporation can generate more money for its operations through an Initial Public Offering (IPO). A business can swiftly obtain a sizable quantity of money by offering shares of their firm to the general public. 
  • Gain in Business Credibility: When a company decides to go public, it has to follow certain rules outlined in the Companies Act. This commitment to following these rules boosts the company's reputation with investors, building trust and possibly bringing in new sources of funding. 
  • Access to Debt funding: Publicly traded businesses have more access to debt funding than private businesses. Companies who need to fund significant projects or acquisitions may find it useful. 
  • Brand Image Improvement: Going public can contribute to an improvement in a company's brand image and visibility in the Indian market. This increased visibility can attract more partners, suppliers, and clients.  
  • Employee Benefits: Offering shares to employees as part of an IPO can enhance employee morale and motivation. It aligns the interests of employees with the company's success, fostering a sense of ownership and loyalty.

Disadvantages of IPOs 

Here you can check the disadvantages of IPOs: 

  • Costly Procedure: Making a public offering is a costly procedure. To be ready for the IPO, businesses must pay expensive fees to accountants, investment banks, and attorneys. 
  • Increased Regulatory Compliance: Before going public, businesses must abide by several requirements. For businesses, it may be highly expensive and time-consuming. 
  • Loss of Control: After a firm becomes public, its founders and management can no longer have complete control over it. Some business owners may find it challenging to accept. 
  • Increased Risk: A company's risk may increase if it goes public. Due to the rigorous investigation of the company's financials, investors may suffer volatility in the company's shares. 
  • Privacy loss: When a business goes public, it is required to reveal its financials and other information, which may result in a loss of privacy.

Types of Investors in IPO 

When it comes to IPO investments. It is classified into three categories which are as follows: 

  • Qualified Institutional Buyers (QIBs)

    Comprises large investment firms, mutual funds, scheduled commercial banks, and SEBI-registered organisations. In a book-built issuance, allocation is restricted to a maximum of 50% of the securities. Compulsory book-built issues must reserve a minimum of 75% of the securities for QIBs.

  • Retail Individual Investors (RII)

    Individual investors with a total investment value of up to 2 lakh rupees. In a book-built issue, a minimum of 35% of shares is designated for this group. Forced book-built issues allow a maximum allocation of 10%. In fixed-price issuances, at least 50% of shares are allocated.

  • Non-Institutional Investors

    Encompasses investors outside QIBs and retail clients, such as High Net Worth Individuals (HNIs) and business entities. At least 15% of stocks are set aside for this group in book-built issues. Mandatory book-built issues restrict the allocation to no more than 15% for non-institutional investors.

How are IPO Shares Allocated to Each of the Investor Categories? 

There is a different formula for allocating shares to each of these categories: 

  • For example, in the case of retail investors (up to Rs2 lakhs per IPO), the gross demand will be evaluated based on the number of applications received. The issue is said to be oversubscribed when the demand exceeds the allocation. 
  • The retail category is allotted shares based on a lottery in such cases. This is a computerised process that ensures fair allocation of shares to investors. However, the guiding principle is that every individual who has applied for the minimum lot can get some shares. 

In the case of QIB, the allocation is done on a discretionary basis, while for NIIs, it is done on a proportionate basis. However, as per the recent notification by SEBI, even the NII category allocation will be done on a lottery basis, like the retail quota.

How does a Company Benefit from an IPO? 

An Initial Public Offering (IPO) offers several advantages to a company and they are as follows:

  • It has the advantage of opportunity for companies to secure new capital and facilitate exits for early investors.
  • Raised capital can be utilised for expansion, diversification, and other strategic initiatives.
  • Listed companies gain broader acceptance due to increased transparency and necessary disclosures.
  • Crucially, an IPO facilitates stock listing, fostering wealth creation for shareholders and establishing a valuation foundation.
  • The listing becomes a valuable currency for future inorganic growth.

The Initial Public Offering (IPO) is a closely observed event in financial markets, representing an opportunity for investors. It carries the potential for either financial gains or losses. Investors who are attracted by possible discounts, often show interest in IPOs. Over time, the price of an IPO tends to stabilise and find a consistent value in the market. If you wish to participate in the latest IPO, you can do so by opening a free Demat account app which allows you to engage in the trading and investment activities associated with the IPO.

FAQs on Initial Public Offering (IPO)

The minimum investment can vary between INR 10,000 and 15,000. Investors can contribute either that specific amount or its multiples, depending on the lot size.

The typical lot size in the stock market is 100 shares, representing the quantity of shares involved in a regular transaction for buying and selling.

Despite the fact that the terms stock and share are sometimes used interchangeably, an IPO refers to the sale of stock by a firm. 

An IPO investment may be a wise choice. You could gain later when the price rises over time if you buy a stock with significant upside potential at the beginning.

To calculate IPO profit, subtract the buying price (the asset's cost at the purchase time) from the selling price (the rate at which it's sold). Divide the result by the purchase price to determine profit times on the invested capital.

Companies go public via an IPO to generate cash for a range of reasons, including supporting expansion, paying off debt, making acquisitions, and providing liquidity for current shareholders. 

The majority of the time, anybody with a brokerage account is eligible to invest in an IPO, however there may be limits or limitations depending on the investor’s location, net worth, and financial expertise.