What is an IPO? Meaning, Types, Process, Benefits & Risks Explained

Every listed company starts as a privately owned business. As the business grows, its existing funds may not be enough to support expansion. Frequent bank loans may also affect its financial position.

So, many companies decide to open their ownership to the public, allowing more investors to become shareholders in the company. This is where an Initial Public Offering (IPO) comes in, where a private company raises money by offering its shares to the public for the first time.

What is an IPO in the Stock Market?

As the term suggests, IPO is the process of a company offering its shares to the public for the first time. It often does so when the company wants to raise money from the public for business requirements. Those investors who apply for the IPO and receive shares become shareholders of the company.

An IPO takes place in the primary market. After the IPO, shares are listed on the stock exchange. This is the secondary market where they become available for trading.

For example, Zomato launched its IPO in 2021. It raised ₹9,375 crore through the issue. The fresh issue was mainly meant to fund the company's growth plans. A part of the proceeds was also used for general corporate purposes. Today, the company's shares are traded on the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE).

How Does an IPO Work?

An IPO is where a company issues its shares to the public for the first time. So, IPO investors do not follow the standard process of placing a buy order in the market. Instead, they submit an application. Shares are allotted to them only if the application goes through successfully.

An IPO process usually has the following steps:

• A company offers its shares to the public through an IPO.

• Investors submit their applications before the due date.

• The issue closes after the last day of bidding.

• Shares are allotted to successful applicants.

• The allotted shares are credited to the demat accounts.

• The company's shares are then listed on the stock exchange.

IPO Lifecycle Explained

An IPO takes shape over several months. A lot happens before investors get a chance to apply. Even after the issue closes, there are a few more stages before the shares begin trading.

• Planning

The company appoints merchant bankers to manage the IPO. These bankers, along with the company's management, finalise the details of the IPO, such as the issue size, type, objectives of the IPO and so on. They then prepare mandatory documents like the Draft Red Herring Prospectus (DRHP). This contains all the necessary information about the IPO.

• SEBI Approval

The DRHP is submitted to the Securities and Exchange Board of India (SEBI). The regulator provides observations accordingly, which the company must address before filing the Red Herring Prospectus (RHP), before the issue opens.

• Application

The IPO is open for a limited number of days. Investors can apply through Application Supported by Blocked Amount (ASBA) or UPI during this period. Once the issue closes, applications are no longer accepted.

• Allotment

The registrar checks all valid applications before deciding the allotment. An oversubscribed IPO is one where investors bid for more shares than the company has offered. In such cases, some investors may not receive any shares. The blocked amount is, therefore, released back to their bank account.

• Listing

Successful applicants receive the shares in their demat accounts before the listing date. The company is then listed on the stock exchange. From that day onwards, the shares can be bought and sold on the secondary market.

Why do Companies Launch an IPO?

Companies usually launch an IPO when they need access to a larger pool of capital. The funds raised can support different business requirements. The exact purpose is mentioned in the offer document before the issue opens.

The following are some common objectives behind an IPO:

• Some companies raise money to expand their existing business

• Existing loans may also be repaid using a part of the IPO proceeds

• To buy a new manufacturing unit or additional equipment

• For working capital requirements

• To give an exit to existing shareholders through an Offer for Sale (OFS)

To become a listed company and improve the company's visibility among investors

Why do Investors Invest in IPOs?

Every investor may have a different reason for applying to an IPO. However, before applying, it is important to understand the company's business, financial performance and associated risks.

• Some investors want to become shareholders in a company from the very beginning.

• Listing gains are another reason many investors apply for IPOs.

• Some investors participate in IPOs to diversify their investments across different sectors.

• Some IPOs open at a reasonable issue price. Investors may enter to benefit from such low prices.

• Investors may apply when they have confidence in the company's management and business model.

• Companies operating in fast-growing industries often receive strong investor interest.

Types of IPO

Not all IPOs follow the same structure. They can be grouped in different ways depending on how the shares are priced, who is selling the shares and the type of company launching the issue.

Based on Pricing

• Fixed Price IPO

In a fixed price IPO, the company announces the issue price before the subscription period begins. Investors know the exact price they have to pay while submitting their applications. This method is less common today and is mostly seen in the SME segment.

Example: Teja Engineering Industries Ltd IPO

• Book Building IPO

A book building IPO allows investors to bid within a price band decided by the company. Once the issue closes, the investor demand is assessed. On that basis, the company decides the final issue price.

Example: Hyundai Motor India Ltd IPO

Based on Issue Type

• Fresh Issue

In a fresh issue, the company creates new shares. The money raised goes directly to the company. Business expansion, debt repayment and other business-related expenses are usually met by these funds.

Example: Waterways Leisure Tourism Ltd IPO

• Offer For Sale (OFS)

No new shares are created under this category. Existing shareholders sell their shares through an IPO. The sale proceeds are used to compensate selling shareholders.

Example: LIC IPO

• Hybrid Issue

A hybrid issue combines a fresh issue with an Offer for Sale. The company raises fresh capital through new shares. Existing shareholders also get an opportunity to sell part of their holdings.

Example: Swiggy IPO

Based on Market

• Mainboard IPO

A company that intends to list on the main stock exchanges launches a mainboard IPO. The issue size of IPOs here is usually larger. Only companies that satisfy all the listing requirements can issue a mainboard IPO. These shares are listed either on the NSE, the BSE or both.

Example: Innovision IPO

• SME IPO

These IPOs are meant for Small and Medium Enterprises (SME). They are listed on the SME platform of the NSE or BSE. These IPOs usually have a smaller issue size compared to mainboard IPOs.

Example: Millworks Technologies Ltd IPO

Who can Invest in an IPO?

Most resident Indian investors can apply for an IPO. However, they must meet the basic eligibility requirements. Companies reserve different portions of the issue for different categories of investors. The following are some categories of investors who can invest in an IPO.

• Retail Individual Investors (RIIs).

• Non-Institutional Investors (NIIs) or High Net-worth Individuals (HNIs).

• Qualified Institutional Buyers (QIBs).

• Eligible employees, if an employee reservation is available.

Eligibility to Apply for an IPO

Applying for an IPO is simple. However, a few basic requirements must be met before an application can be submitted.

• Individuals must be at least 18 years of age.

• A valid PAN card is mandatory while applying.

• IPO shares are credited only to a demat account.

• Applications can be submitted through a trading account linked to a registered broker.

• The bank account should support ASBA or UPI payments.

How to Apply for an IPO?

Applying for an IPO has become much simpler today. With online investing platforms, investors can submit their applications without visiting a bank or broker's office.

The following steps are usually involved while applying for an IPO:

• Keep your PAN, demat account and trading account ready.

• Check the IPO dates and read the Red Herring Prospectus (RHP).

• Select the number of lots and place your bid.

• Approve the UPI mandate or apply through ASBA.

• Wait for the allotment.

• If shares are allotted, they are credited to your demat account.

How IPO Shares are Allotted

Every IPO receives a different response from the public. Some issues are undersubscribed. In such cases, every applicant gets the number of shares they apply for. In other cases, the issue is oversubscribed. Subscription then happens via a lottery-based method.

The following steps are usually followed for allotment:

• A registrar receives all valid IPO applications.

• Retail, HNI and QIB applications are processed separately.

• Oversubscribed IPOs follow SEBI's allotment rules.

• Some applicants receive allotment. Shares are credited to their demat accounts in a few days.

• Some applicants may not receive allotment. The blocked money in their bank account is then released.

Advantages of Investing in IPOs

IPOs offer investors a way to participate in a company's transition from a private business to a publicly traded one. However, every IPO should be evaluated carefully before making an investment decision.

Here are a few benefits of investing in an IPO:

• Investors buy shares at the issue price and not the market price.

• Unlike listed companies, IPOs come with a detailed disclosure in the Red Herring Prospectus.

• Investors are free to hold their shares or sell them on the stock exchange.

• For companies that perform well after listing, an IPO investment can become part of long-term wealth creation.

• The entry point for retail investors is often lower compared to other investor categories.

Risks of Investing in IPOs

Applying for an IPO does not guarantee positive returns. Several factors like market conditions and investor sentiment come into play. Hence, every investment decision should be based on proper research.

Here are a few risks involved:

• A stock may list below its issue price.

• Over-subscription can reduce the chances of allotment.

• Newly listed companies have a limited track record in the stock market.

• Market sentiments post-listing may change.

• You cannot always predict short-term price movements.

• Future business performance cannot be analysed with certainty.

IPO vs FPO vs OFS

Companies can raise or sell shares in different ways. An IPO is only one of them. FPOs and OFSs are other options. They also involve raising money from the public, but they serve different purposes and are offered under different circumstances.

IPO vs Direct Stock Market Investing

An IPO and stock market investing both involve buying shares. The difference lies in when those shares are purchased. An IPO allows investors to buy before listing. A direct purchase on the stock market happens after the shares begin trading.

Common Mistakes to Avoid while Investing in IPOs

Many investors get carried away when a popular IPO opens for subscription. A little preparation can help you avoid the following mistakes and make better investment decisions.

• Applying because everyone else is – A popular IPO is not always a good investment. Look at the company instead of following the crowd.

• Skipping the RHP – The Red Herring Prospectus explains the company's business, finances and risks. Spending a few minutes on it can be worthwhile.

• Chasing listing gains – Not every IPO lists above its issue price. Some stocks may even open below it.

• Investing more than you can afford – Apply with an amount that fits your budget. Avoid putting too much money into a single IPO.

• Ignoring the company's fundamentals – Check how the business has performed over the years. Strong demand alone is not enough.

• Applying to every IPO – Every public issue is different. It is perfectly fine to skip an IPO that does not match your investment goals.

How to Evaluate an IPO before Investing

Every IPO looks attractive during the subscription period. That does not mean every issue is worth investing in. Looking at a few important factors can help you make a more informed decision.

• The company's business – Start with what the company actually does. If the business is difficult to understand, take more time before investing.

• Financial performance – Revenue, profit and debt figures tell an important story. Compare the numbers over the last few years instead of looking at a single year.

• Reason for the IPO – Understand the objectives of the IPO. This will tell you where the company is heading.

• Company valuation – An expensive IPO is not necessarily a bad one. The pricing should make sense when compared with its peers.

• Risk factors – Understand the risks involved. These are explained in the Red Herring Prospectus (RHP).

• Promoters and management – The people running the company matter too. Check their experience and track record.

Important Factors that Influence IPO Performance

No two IPOs perform in the same way. Some list at a premium, while others do not. A few factors can influence how an IPO performs after listing.

• The market – A rising market can support IPO demand. A weak market may reduce investor interest.

• Investor response – Some IPOs are fully subscribed within days. Others take longer to attract applications.

• The company's financials – Investors usually check revenue, profits and debt. These figures are available in the offer document.

• The industry – Some sectors are in focus at certain times. That can influence the response to an IPO.

• The issue price – Investors often compare the IPO price with similar listed companies. It gives them another point of reference.

Best Practices for First-Time IPO Investors

There is no need to rush into every IPO. A little preparation before applying can make the investment process more comfortable, especially for first-time investors.

• Know why you are investing – Some people apply for listing gains. Others invest with a long-term view. Having a clear objective can make decisions easier.

• Spend some time on the offer document – The Red Herring Prospectus explains the company's business, finances and risks. It is one of the best sources of information available to investors.

• Decide your investment amount early – It helps to know how much you are comfortable investing before the IPO opens. This avoids last-minute decisions.

• Do not depend on market rumours – IPO discussions are common on social media and online forums. It is always better to rely on official information.

• Missing an IPO is normal – New public issues come to the market regularly. Skipping one opportunity does not mean missing out forever.

Making Informed IPO Investment Decisions

Understanding what an IPO is helps investors make informed decisions before applying for a public issue. Learning how an IPO works, why companies launch it, and the risks involved can make the investment process easier. Always evaluate the company's fundamentals and investment objectives before making your decision.