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What Is IPO In Stock Market
There are a lot of terms and concepts to know before you step into the world of investments and trading. One such concept is what is IPO in the stock market. There is a possibility that investing in an IPO can lead to bountiful returns and other benefits. But just like everything in the world of trading, IPO also comes with its fair share of risks.
For a first-time trader, you must do your homework and study well before trading and investing in an IPO. Hence, you must know what it is, how it processes, and how it differs from other stock tradings. Here, we will look into that, trying to give you a good idea of what it is and how it works. While we are at it, we will also add a few tips on investing in them wisely.
Understanding IPO: The Primary and Secondary Market
When a private company decides to go public, it does so by issuing a particular amount of its share to the public for public investment in the Primary Market. To explain it in simple terms, the Capital Market observes two main types of co-existing segments — the primary and secondary markets.
The primary market is for the new issuers, where private companies or start-ups offer their shares up for public investments for the first time, thus transitioning into a public company. The secondary market or the stock market is where the companies can further actively form capital through the distributed shares. It is also the market where investors can liquidate their initial investments. So, the process starts at the primary market with the issuance of new shares and shifts to the secondary market, where the shares are put in a continuous churn for capital formation.
When a company issues its first shares or securities and goes public, those shares are what we term Initial Public Offerings or IPO in the stock market. For a company going public, it is one of the largest sources of capital with indefinite maturity. It helps the company secure funds for expansion and further development. IPO is also an excellent source for boosting company publicity and credibility and is the quickest way to secure funds for rapid expansion. Note that when a company issues a large amount of IPOs all at once, it indicates a good and healthy economy.
From the investors’ and shareholders' point of view, when you invest in an IPO, you are investing in its 'Share Capital'. This means you directly become one of the company's owners, forming a direct relationship with it. If you want to withdraw your investment, you can do so through the secondary market, where you sell your shares and thus exit the investment. This offers you a sense of security where you can liquidate your investments.
Private Going Public: Issuing IPO
Issuing an IPO initiates when a private company or start-up decides to go public and avails its shares to the public for purchase. In other words, the company decides to start accumulating capital with the help of public funding. Once that decision is reached, the company will need a medium to begin the processes. In this case, it appoints an underwriter which essentially is a pool of investment banks. Here are the primary responsibilities of the underwriter:
- Assess the financial requirements of the company
- Decides how many shares should be offered to the public
- Decides upon the price or the range of price of the shares
The next step in the process requires the underwriter to draft the application to the SEBI for approval. With the approval of SEBI, a company may not be able to issue an IPO. Hence, here is another critical role that the underwriter takes on. It is essential to know what details are included in the application draft, so here are the main components:
- Past financial records of the company, which may have net worth, assets, debts or liabilities, profits, and so on
- The manner of utilization of the funds raised from the IPO
Upon receiving the draft, the SEBI thoroughly goes through it to ensure that the company meets all the eligibility factors. After meeting the criteria, the SEBI approves and allows the company to release the Red Herring Prospectus.
The Red Herring Prospectus is nothing more than a document that the company releases. It highlights some key facts regarding the IPO, including:
- Number of shares that will be issued
- Price/price range of the shares
- Information on the past performance of the company
Once the Red Herring Prospectus is released, the Road Show initiates. This is merely a process where company executives meet prospective investors and convince them to buy the company shares.
Soon, the IPO opens, lasting from 3 to 21 days (5 days being the average). During this period, interested investors can bid for the stocks via their brokers or banks over the Internet. If you are interested in participating in an IPO, make sure you have a Demat account and a PAN card. After the stocks you bid for are allotted, you can find them credited to your Demat account. However, your money will be credited back to you if they are not allotted. With that, you now know what an IPO is and how they are issued.
Get Started With IPO Investments
So, we’ve dug into what an IPO is and how a company issues them. Now, moving forward to an investor's interest, let’s discuss how you can get started with IPO investments.
Before getting into details, you need to understand that you need to have a long-term mindset to make an investment that will be worth it. It is important to scrutinise and study the market, the company, and your reasons for investing before taking the leap. So, always ensure you have a good enough plan and expertise before moving forward with your investments. With that, here are five tips you should take away with you before you start your journey of investing in an IPO.
Look at the underwriters
Nothing can be 100% guaranteed, and there have been cases where companies with strong underwriters have disappointed their investors. However, it is still a good place to start with. Therefore, when you are looking to invest in an IPO, always look at the company's underwriter.
As we explained above, underwriters are a pool of investment banks that take on the duty of drafting an IPO application for the company and submitting it to the SEBI for approval. The stronger and more reputed the underwriter, the more you can rely on quality.
Company Research is a Must
As with any trading norms, research is mandatory here if you want to make a good investment and expect high returns. Therefore, when looking forward to investing in an IPO, always do extensive research on the company. Look up its past performances, press releases, industry health, competitors, etc.
Though you may not be able to unearth everything about the company, you should be able to get a good idea about whether the company is worth investing in.
Do Not Overlook the Prospectus
You can get a good amount of information in the company prospectus, so do not ever ignore it. It is one of the places where you can easily find complete (usually) information on the company. A good read of the company prospectus will give you a thorough idea about what the company plans to do with the capital raised from the IPO.
Now, be aware that the company writes a prospectus; hence, you cannot rely on it for complete and unbiased information. However, it is still an excellent way to establish the risks and opportunities you will get from investing in the company. You may acquire a prospectus by requesting the responsible broker for the company.
Attune Yourself to Market Trends
This is true with all trading and investing practices. Once you have decided to invest in a stock, shares, or in this case, an IPO, you must always stay up to date with the current market trends.
Studying the market is an essential skill that investors must possess to make a good investment. If you do not know how to read a market, then that’s fine. You can always do your study and learn as you go. Therefore, in the beginning, you should seek professional advice from expert investors.
IPOs are a great investment, but only when you have good knowledge about them. Companies going from privately owned to publicly-owned issue IPO to invite the public to buy their shares and invest in the company. These investments directly reflect on the companies as their Share Capital, which is then used for further expansion and growth of the company.
Hence, investments of any kind should be backed with sufficient research, study, knowledge, and expert advice. So, when preparing for an IPO, you should study the company and its past performances, look into the market trends, and seek expert advice if it is your first time investing in an IPO.
Frequently Asked Questions
What is IPO's full form in the stock market?
IPO stands for Initial Public Offerings.
What is IPO meaning in the stock market?
IPO is the process through which a private company offers first to sell its shares to the public. Through IPO, a private company can transition to become a publicly owned company.
Can I exit investments I made in the IPO?
Yes, you can exit your investments in the IPO through the Stock (Secondary) Market by selling the shares through it.
Do I need anything to participate in an IPO?
Yes, you must have a Demat account and a PAN card to participate in an IPO.
What is the Red Herring Prospectus?
The Red Herring Prospectus is a document released by the company before the opening of the IPO. It contains crucial details such as the number of shares offered in the IPO, their price/ price range, and the company's performance over the years. It is released after the SEBI approves the company's IPO request.
How long does the IPO open for?
The IPO opens for 3 to 21 working days, though it stays open for mostly five working days.
How do I acquire the company prospectus?
You may acquire the company prospectus from the broker in charge of making the company go public. All you will have to do is put in a request for the prospectus with them.
What are the few things I should consider while investing in an IPO?
Few things to assess while investing in IPO are:
- Always study the company you want to invest in
- Stay updated on market trends
- Lookout for strong brokers