Initial Public Offering (IPO): Full Form, Meaning, Types, Benefits, Share Price & How To Invest
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11 JANUARY, 2024

IPO stands for Initial Public Offering, marking the pivotal transition of private companies into publicly traded entities. This strategic process involves the sale of shares to the public, facilitating the infusion of equity capital. This transformative event elevates the company's status to a publicly traded entity. Simultaneously, it provides savvy investors a lucrative opportunity to secure substantial returns on their investments in the open market.

What is an IPO?

An IPO is the pivotal process wherein private companies transition into public entities by selling shares to the public, thereby raising essential equity capital. This transformative event turns a privately held company into a publicly traded one and presents a unique opportunity for astute investors to reap handsome investment returns. Investing in an IPO requires informed decision-making, as each opportunity has benefits and risks. It involves the initiation of selling a portion of the company's stake to institutional investors, high net-worth individuals (HNIs), and the public, detailed in a comprehensive prospectus. Following a successful IPO, the listed shares are freely tradable in the open market.

How Does Initial Public Offering Work?

Launching an IPO is a significant step for any company, offering opportunities for growth, expansion, and increased visibility in the market. By understanding each step of the IPO process carefully, companies can position themselves for success in the dynamic world of public markets.

1. Engaging an Underwriter or Investment Bank

The journey towards an IPO begins with selecting an underwriter or investment bank. These financial experts play a pivotal role in analysing the company's financial health, managing the overall IPO issuance, and acting as a bridge between the company and potential investors.

2. Preparing for IPO Registration

Companies in India must adhere to IPO guidelines by regulatory bodies like SEBI. The first step involves crafting a comprehensive registration statement and a Draft Red Herring Prospectus (DRHP). These documents give potential investors essential insights into the company's operations, financials, and plans.

3. SEBI Approval and Verification

Once the registration statement and DRHP are ready, they are submitted to the SEBI for approval. It meticulously verifies the disclosed information to ensure accuracy and transparency. Upon successful verification, the company receives the green light to proceed with its IPO plans.

4. Listing on Stock Exchanges

With SEBI's approval secured, the company can apply to list its public offering on the stock exchanges. This crucial step marks the company's official entry into the public trading arena, allowing investors to buy and sell its shares on the open market. 

5. Strategic Marketing Initiatives

Companies embark on comprehensive marketing campaigns to generate interest and attract potential investors. These efforts may include social media outreach, roadshows, advertisements, and investor presentations to showcase the company's value proposition and growth potential. 

6. Setting the Price

Determining the offering price of the shares is an important decision for the company. It can be accomplished through either a Fixed Price or Book Building Offering method, each with its considerations and implications. 

7. Facilitating the Bidding Process

Investors can place bids within the specified price range during the bidding process. This phase typically spans several days, allowing investors to adjust their bids before the final allocation. 

8. Allocation and Allotment

Following the conclusion of the bidding process, the company, in conjunction with the underwriters, allocates shares to successful applicants. In cases of oversubscription, partial allotments may be made to ensure fair distribution.

Benefits of investing in an IPO

Here are the various benefits of investing in an IPO: 

- Increased Recognition: Going public elevates a company's reputation and credibility, fostering trust among stakeholders and investors. Moreover, publicly traded companies often enjoy greater visibility and recognition than their private counterparts, attracting media attention and investor interest.

- Access to Capital: Another significant benefit of investing in an IPO is access to capital. IPOs provide substantial capital, enabling companies to fuel growth initiatives, expand operations, invest in research and development, and address debt obligations. This capital infusion can propel a company into a new phase of financial stability, supporting strategic initiatives and fostering long-term growth.

- Diversification Opportunity:  Public offering of shares also offers investors a valuable diversification opportunity. Publicly listed companies attract a diverse range of investors, reducing reliance on a single funding source and enhancing portfolio diversification for shareholders. Additionally, publicly traded stocks offer investors the opportunity to diversify their investment portfolios and participate in the growth potential of emerging companies.

- Management Discipline:  Investing in an IPO promotes management discipline within a company. Going public encourages a greater emphasis on profitability and financial performance, driving management to prioritise shareholder value and operational efficiency. Furthermore, public companies are subject to heightened scrutiny and accountability, fostering transparency and accountability in corporate governance practices. 

- Third-Party Perspective: Lastly, investing in an IPO provides companies with a valuable third-party perspective. Public listing evaluates a company's business model, strategy, and performance, providing insights for strategic decision-making. Additionally, investor interest and market response to an IPO serve as external validation of a company's value proposition, positioning it for continued growth and success.

Types of IPOs

Investing in an IPO presents distinct advantages, with two common types offering varied benefits.

Fixed Price Offering:

  • Companies set a predetermined issue price for their shares.
  • Investors know the stock price at the time of the public offering.
  • If participating, investors must pay the total share price during the application.

Book Building Offering

  • The company offers a 20% price band on the stocks.
  • Interested investors bid on shares before the final price is determined.
  • Investors specify the number of shares and the amount they are willing to pay per share.
  • The floor price is the lowest, and the cap price is the highest, with the final price determined by investors' bids.

Advantages and Disadvantages of an IPO for Companies

Advantages of an IPO:

  • Increased Recognition: Going public enhances a company's reputation, making it more credible and trustworthy. Publicly traded companies typically enjoy greater visibility than their private counterparts, attracting media attention in the financial sector.
  • Access to Capital: An IPO provides a significant influx of capital, allowing companies to reshape their growth trajectory. It helps them excel in their respective industries.

Disadvantages of an IPO:

  • More Costs: IPOs entail considerable expenses, from ongoing regulatory compliance to upfront costs for underwriters, investment banks, and advertisers.
  • Extra Pressure: Publicly traded firms face immense pressure to maintain high stock values, potentially sacrificing long-term planning for immediate gains during market turmoil. Executives may be constrained in making bold decisions if stock prices are at risk.

Eligibility Criteria for Offering an IPO

For a company to offer an Initial Public Offering (IPO) in the Indian stock market, it must fulfil several regulatory and procedural requirements. Here is a general outline of the steps and requirements:

  • Eligibility Criteria: The company must be incorporated under the Companies Act, 2013. It should have a track record of profitability, positive net worth, and minimum net tangible assets.
  • Compliance with SEBI Regulations: The Securities and Exchange Board of India (SEBI) is the regulatory authority for securities markets in India. The company must comply with SEBI regulations regarding IPOs. SEBI prescribes various disclosures, corporate governance, and investor protection norms that companies must adhere to.
  • Appointment of Intermediaries: The company must appoint various intermediaries such as investment bankers, underwriters, and other professionals involved in the IPO process.
  • Due Diligence: Conduct a thorough due diligence process to ensure that the company's legal and financial aspects are in order. This includes auditing financial statements, legal compliances, and business operations.
  • Drafting the Prospectus: Prepare a detailed prospectus that includes information about the company's business, financials, risks, and the purpose of the IPO.
  • Board Approval: Obtain approval for the IPO from the company's board of directors.
  • Approval from Shareholders: Seek approval for the IPO from the company's shareholders through a special resolution.
  • Filing with SEBI: Submit the draft prospectus and other required documents to SEBI for approval. SEBI will review the documents and provide observations.
  • IPO Pricing: Determine the issue price of the shares in consultation with the lead manager. The pricing is often a function of market conditions and demand for the company's shares.
  • Advertising and Marketing: Conduct campaigns to market the IPO to potential investors. Today, many trading apps, social media influencers, and channels cater to investors.
  • Listing Agreement: Enter into a listing agreement with the stock exchanges where the company intends to list its shares.
  • Allotment and Refund: Allot shares to investors and ensure the refund of excess application money.
  • Listing on Stock Exchanges: After completion of the allotment process, the company's shares are listed on the stock exchanges.

It's important to note that the regulatory framework may be subject to changes, and companies should consult with legal and financial experts to ensure compliance with the latest regulations. Additionally, engaging with reputable investment banks and financial advisors can significantly assist in the successful execution of an IPO.

These eligibility criteria streamline the IPO process, ensuring companies meet the essential documentation and account requirements stipulated by regulatory authorities.

Performance Factors of IPOs

Key factors influencing the performance of IPOs:

  • Lock-Up: IPOs often involve a lock-up period during which company executives and early investors are restricted from selling their shares. This can influence the stock's initial performance by limiting the available supply.
  • Waiting Periods: The time between the IPO launch and the actual listing on the stock exchange is crucial. Investors need to consider waiting periods, ensuring they know when the shares will become tradable.
  • Flipping: Flipping refers to quickly reselling shares for a quick profit. Monitoring trends provides insights into market sentiment and demand, impacting the stock's short-term performance. Understanding these factors is vital for investors navigating the dynamic landscape of IPOs.

Also Read: What is an e-invoice?

Frequently Asked Questions (FAQs)

What is the main purpose of an IPO to the public?

An IPO is the transition point for a private company to become publicly traded. Offering shares to the public raises equity capital, facilitates existing asset trading, and attracts potential investors, marking a significant step in the company's financial journey.

Can any company list an IPO?

While any company can aspire to list an IPO in India, it must meet eligibility criteria set by regulatory authorities such as SEBI. Criteria include financial stability, profitability, track record, and compliance with disclosure norms. Engaging with financial advisors is crucial to navigating regulatory requirements for a successful IPO.

How is an IPO priced?

An IPO's pricing involves methods like fixed pricing or book building. In a fixed price offer, the company sets a predetermined price, while book building involves a price band where investors bid for shares, determining the final price based on demand.

When is an IPO listed?

Once an IPO is completed and shares are allotted to investors, the company's shares are listed on the stock exchange. This usually occurs a few days after the IPO closes.

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