What is IPO in Share Market?

The IPO stands for initial public offering. An IPO is essential when a privately held company changes over to public ownership, offering its shares to the public. Such a move, whether a start-up in its early days of operation or a well-established company, usually shows a tactical decision to list on one of the stock exchanges and increase its shareholder base.

First and foremost, a private company thrives on the support from its promoters, early investors, and stakeholders. When it reaches critical mass and is found tough enough to withstand the strict compliance requirements of SEBI, the management may take the view that the time has come to initiate the IPO process. 

This could result from a desire for funds to increase the scale and diversity of operations. An IPO offers the opportunity for the general public from every part of the country to invest in the company, thereby becoming a part of this growth and success story of the company. Hope this helps you to get a clear understanding of what is an IPO stock, what is IPO meaning, IPO full form in share market. Let’s now further move ahead and understand what is IPO in share market and how it works.

How Does an Initial Public Offering Work?

The IPO enables a company to raise its equity capital by issuing its shares to the public. In all, here is the overall procedure one can go through:

1. The Preparation Phase

A company decides to go public and chooses investment banks to act as underwriters. Due diligence about detailed financial audits and legal compliance scrutiny is then carried out.

2. Submitting the DRHP

The company files a Draft Red Herring Prospectus with SEBI for scrutiny.

3. Selection of Stock Exchange

The company selects the stock exchange on which it will list its shares and applies to the chosen exchange.

4. Roadshow

A roadshow is arranged and presented by the company with its underwriters, whereby it sells the IPO to potential investors.

5. Pricing

The same would be determined based on investor interest and prevailing market conditions.

The final prospectus is issued with the offer price range, and this document is popularly called the Red Herring Prospectus, RHP.

6. Share Allocation

Shares would be allocated to different investor categories, such as Qualified Institutional Buyers, QIBs, Non-Institutional Investors, and Retail Individual Investors. Investors can bid for the shares in the offer price range.

7. Listing on the Exchange

The shares of the company get listed on stock exchanges like NSE and BSE.

8. Commencement of Trading

The shares start trading in the secondary market on the very day when the IPO takes place. The investors can sell and buy the shares at the ongoing market rates.

9. Lock-up Period

Promoters and some shareholders often get restricted in selling their shares during the lock-up period.

10. Post-IPO Reporting

It must give periodic financial and operational updates to the stock exchanges as well as its investors

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 are the 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 number 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

Below are the disadvantages of IPOs: 

• Expensive 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, they are classified into three categories, which are as follows: 

Qualified Institutional Buyers (QIBs)

It comprises large investment firms, mutual funds, scheduled commercial banks, and SEBI-registered organizations. 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. 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 (HNI) 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 ₹2 lakh 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 computerized 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 utilized 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 a 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 are new to this, open an account with the help of 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 have 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 does not need to be paid back to the public investors. 

Conclusion
Understanding what is an 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 stabilize, and a consistent value in the market is found. If you wish to participate in the latest IPO, you need to open a free trading account app, which allows you to engage in the trading and investment activities associated with the IPO.