What is IPO in Share Market?

The IPO stands for initial public offering. The IPO takes place when 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. Hope this helps you to get a clear understanding of what is IPO stock, IPO meaning, IPO in trading. Let’s now further move ahead and understand how IPO in share market works.

How does an Initial Public Offering Work?

After knowing IPO definition, we will understand how IPO works. A corporation often launches an IPO to enhance equity capital, generate funds for the future, permit simple asset trading, or monetise current shareholder interests. 

The lengthy prospectus contains information regarding the initial sale of shares that institutional investors and the general public may evaluate. It provides comprehensive information about the prospective offers. 

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

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 issues an IPO, it allows the public to invest. IPOs give the company a bigger pool of potential investors, enabling it to collect more money than it 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:

• 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 which are listed below: 

Advantages of IPOs

Here are a few advantages of IPOs:

• Capital Raising: An initial public offering (IPO) allows a corporation to generate more money for its operations. A business can swiftly obtain a sizable quantity of money by offering shares of its firm to the general public.  
• Gain in Business Credibility: When a company decides to go public, it must follow specific rules outlined in the Companies Act. This commitment to following these rules boosts the company's reputation with investors, builds trust, and possibly attracts new sources of funding. 
• Access to Debt funding: Publicly traded businesses have more access to debt funding than private businesses. This may be helpful for companies that need to fund significant projects or acquisitions. 
• 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 as part of an IPO can enhance employee morale and motivation. It aligns employees' interests 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 prepare 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, which 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 must 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 50% of the securities. Compulsory book-built issues must reserve at least 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. In book-built issues, at least 15% of stocks are set aside for this group. 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.
• In such cases, the retail category is allotted shares based on a lottery. This is a computerised process that ensures a 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 discretionary, while NIIs are proportionate. 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 providing companies with the opportunity 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, creating wealth for shareholders and establishing a valuation foundation.
• The listing becomes a valuable currency for future inorganic growth.

Things You Should Know Before Investing in an IPO

The following is the breakdown of several things that an investor needs to consider while investing in an IPO:

• You should consider the risks and rewards involved in investing in an IPO. If you're new to this, peruse an account from an expert or a wealth management firm. Additionally, it is also suggested that you seek advice from a personal financial advisor if you are uncertain.
• It is the asset of your portfolio that has the highest potential for rewarding returns. In contrast, it could also silently sink your investment. Keep in mind that stocks undergo market volatility. 
• If you've purchased an IPO from a company, you are tied to that company's fortunes. Your well-being is impacted directly by its successes and failures. 
• It’s important to know that a company offering its shares to the public is not obliged to reimburse the capital. The capital doesn’t need to be paid back to the public investors. 

Conclusion
Understanding what is initial Public Offering (IPO) is crucial for investors. It 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 a consistent value in the market is found. If you wish to participate in the latest IPO, In that case, you can open a free Demat account app, which allows you to engage in the trading and investment activities associated with the IPO.