What Is IPO In Stock Market

When companies require more capital to fund their growth, they can either borrow a large loan and pay hefty interest on it or sell shares of their company. Some companies opt for the latter and launch their IPO.

Let’s understand what an IPO is, its types, pricing methods and how to apply.

What is an IPO in the Share Market?

An IPO is the process through which private companies raise capital from the general public by selling their shares and going public. This helps move capital from investors who seek investment avenues to companies that require it.

Different categories of investors, such as High Networth Individuals (HNIs), institutional investors and retail investors can participate in the IPO. Investors can access the Red Herring Prospectus (RHP), which is a preliminary registration document filed with SEBI to gain more details about the IPO.

Types of IPO

In India, there are two types of IPOs: Fresh Issue and Offer for Sale.

Fresh Issue

A fresh issue in the Initial Public Offering (IPO) refers to companies that are issuing new shares for the first time to the public without selling the stake of the promoters. The company gets listed on the stock exchanges, such as BSE and NSE, for the first time and enters the secondary market.

Since the promoter’s shares are not sold in fresh issues, it shows the founders and promoters confidence in the company's growth and future potential, and they refrain from selling their shares.

The capital raised via IPO is used to fund the expansion and growth strategy of the company, acquire new companies, invest in research and development for innovative products and services and to meet working capital requirements.

Offer for Sale

In an offer for sale, the company clearly states that the shares held by the company's promoters are being sold and no additional shares will be issued to the public. The funds raised from OFS directly go to the company’s promoters who want to sell their shares and exit the company, and not to the company.

IPO Pricing Method

There are two IPO pricing methods to pre-determine the price of shares: Fixed Price & Book Building Process.

Fixed Price

In the fixed price process, the prices of the shares are fixed at a specific price. The company issuing the shares hires investment banks and underwriters to fix the price for the IPO. The investors have to bid for the shares at the fixed price.

In this process, the investor has made the full payment upfront, which is refunded to their linked bank account if they aren't allocated the shares. The demand for the IPO is determined after the subscription window ends.

In the fixed price issue, 50% of the total shares are reserved for retail investors with investments below ₹2 lakh. The remaining 50% is reserved for QIBs, NIIs and HNIs with investments over ₹2 lakh.

Book Building Process

The book building process is the most common IPO pricing method used to price the shares of a company. In this approach, the company contacts investment banks and underwriters to fix a price range for the shares and the investors are asked to bid for the shares within the price range.

In the book building process, 35% of the total shares are reserved for Retail investors, 15% for Non-institutional investors and up to 50% for QIBs.