What is IPO in Share Market?
- 01 Mar 2024
- By: BlinkX Research Team
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.
Table of Content
- How does an Initial Public Offering Work?
- Types of IPOs
- Why are IPOs Generated? What is the Need for Launching IPOs?
- Terms Associated with IPOs
- Advantages and Disadvantages of IPOs
- Types of Investors in IPO
- How are IPO Shares Allocated to Each of the Investor Categories?
- 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).
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:
Term | Explanation |
---|---|
Issuer | The business offers stocks in an IPO to raise money. |
Underwriter | A banker, financial institution, or broker assisting the firm in underwriting the IPO, acting as a middleman between the public and the issuer. |
Price Band | The range of lower and higher share prices at which a firm plans to go public. |
Issue Size | In an IPO, the total value is obtained by multiplying the quantity of shares issued by the value of each share. |
Under Subscription | When the public shows less interest in the shares than the firm has issued, resulting in an under-subscribed situation. |
Oversubscription | A situation where the firm receives more applications for shares than the available quantity, leading to an oversubscribed scenario. |
DRHP | Draft 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. |
RHP | Red 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:
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.
Conclusion
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.