What is an IPO in the share market?

IPO or Initial Public Offering is an offer of shares made by a company to the public for the first time. After an IPO, the shares bought by the public can be traded on the share market. This article is an introductory guide to an IPO.

Key Points:

  1. Companies offer shares by going public in order to get access to a large amount of capital.
  2. SEBI carefully scrutinises the application and after making sure that all eligibility norms are fulfilled, it gives the company the go ahead to file an IPO.
  3. IPOs can be accessed through banks and brokerages that have undertaken to conduct the IPO proceedings on behalf of the company.
  4. Once an IPO closes only then does the company get listed on the stock exchange.

In an IPO or initial public offering, the offered shares are bid upon and successful bidders are allotted shares. The term ‘public’ encompasses private institutions and financial institutions called Qualified Institutional Investors (QII). Simply put, companies offer part ownership in exchange for money. If the company grows, the value of the shares you hold in the company increases, profiting you. If the company fails to perform, your share value drops down.

But, why do companies feel the need to raise money through IPOs? Here are some reasons to go public.

Why is an IPO needed?

  1. Easy access to huge capital- This is the primary reason companies offer shares through IPOs. It’s often hard to raise large amounts of money from private investors. Settling debts could be a part of the aim of a company, however, more often than not companies are looking towards increasing the working capital they have on hand in order to improve their company’s performance.
  2. Increase in credibility – Getting listed in a stock exchange adds credibility to the company. This can be quite useful in many situations.
  3. Helps find market valuation – An IPO helps gauge public sentiment towards the company’s future prospects and its market value, that is, how much it is valued and demanded by the public.
  4. Reward for private investors – IPO offers an exit route for private investors who can now sell off their shares at huge profits or just see their net worth rise manifold as the shares gain in value.

How does an IPO work?

Here’s what companies have to do to file an IPO.

  • A private company decides to raise capital through an IPO.
  • The company contracts an underwriter, usually a consortium of investment banks which assess the company’s financial needs and decide the price/price band of shares, number of shares to be offered etc.
  • The underwriter then participates in the drafting of the application which is called Draft Red Herring Prospectus (DHRP) that is sent to SEBI (the regulatory authority for approval with details of the company’s past financial records including profits, debts/liabilities, assets and net worth. Also, the draft mentions how the funds to be raised will be used.
  • SEBI carefully scrutinises the application and after making sure that all eligibility norms are fulfilled, it gives the company the go ahead to file an IPO. The company then releases a ‘red herring prospectus’.
  • The ‘red herring’ prospectus is a document released by the company mentioning the number of shares and the issue price/price band (price of one share) to be offered in the IPO. It also has details of the company’s past performance. In short it is encyclopedia of the Company.
  • In what is called a ‘Road show’, company executives travel to meet with and woo potential investors to buy their company’s shares.
  • The IPO opens for public investment and can last for about 3 days, though it might even be open for 5 days depending on the demand.
  • During this time, retail investors can bid for stocks through their banks/brokerages via the internet.
  • Investors need to have a demat account to participate in an IPO. A PAN Card is a mandatory document in order to open a demat account.
  • If the stocks you bid for are allotted to you, they’ll be credited to your demat account. If not, you’ll get your money back.

And here’s how you take part in an IPO and bid for shares.

How to bid for shares in an IPO?

  • Make sure the IPO is open to retail investors.
  • IPOs can be accessed through banks and brokerages that have undertaken to conduct the IPO proceedings on behalf of the company.
  • You need to have a mandatory demat account to bid for shares.
  • You can bid for shares from an IPO either online or offline through ASBA (Application Supported by Blocked Amount) facility only.
  • For offline bids, you’ve to fill in the specific application form available with banks and brokerages, given that they open up an IPO to their clients. You can bid online through the bank/brokerage’s website which will be done through ASBA as well.
  • After the bid is done, shares will be allotted to you in full, or apportioned among bidders in case of oversubscription, that is, you’ll receive a part of what you’ve bid for.
  • The shares are credited to your demat account or a refund is made for unsuccessful bids.

Finally, companies get listed in a stock exchange after the IPO comes to a close. Stock exchanges have their own norms based on which they list a company and allow trade on their exchange. IPO is the first stage wherein a company goes public. The next stage is the secondary market where securities are traded.

Wrapping Up

  • An IPO is an initial offer of shares to the public made by a company to raise capital.
  • Companies file IPOs to raise money, expand, pay off debts, gain credibility, gain negotiating power, to get market valuation and to reward private investors.
  • Companies go through a long regulatory process before they can bring an IPO out for public investment. SEBI acts as the regulatory authority.
  • You can bid stocks in an IPO either online or offline if the IPO is open to retail investors. You need to have a demat account.
  • IPOs can be a rewarding investment if you choose wisely. To know more about IPOs and for tips and strategies on how to invest in IPO.
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