A company can spend years building a business before reaching a point where it wants the public to own a piece of it. That is where an Initial Public Offering, or IPO, comes in.
For investors, an IPO can be the first chance to buy shares in a company before they begin trading on a stock exchange. But applying for an IPO is not the same as simply buying a stock. There is a separate process involving pricing, bidding, allotment and listing.
So, what exactly happens between a company announcing an IPO and its shares appearing on the stock market?
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What Is An IPO?
IPO stands for Initial Public Offering.
It is the process through which a company offers its shares to the public and seeks to get its securities listed on a stock exchange.
In simple terms, a privately held company opens up part of its ownership to public investors.
The IPO takes place in the primary market. This means investors are subscribing to securities being offered as part of the issue. Once the shares are listed, they can be bought and sold between investors in the secondary market.
SEBI describes an IPO as a public issue of securities in the primary market. NSE also defines an IPO as the sale of securities to the public in the primary market.
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Why Does A Company Launch An IPO?
The biggest reason is usually raising capital.
A company may want money to expand its operations, build new facilities, repay certain borrowings, fund working capital or pursue other objectives disclosed in its offer documents.
But an IPO can involve more than new shares.
There are two basic components:
Fresh issue: The company issues new shares. The money raised goes to the company, subject to the stated purpose of the issue.
Offer for Sale, or OFS: Existing shareholders sell some of their shares to the public. In this case, the money from those shares goes to the selling shareholders rather than the company.
An IPO can also contain a combination of a fresh issue and an OFS.
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The IPO Journey Starts Before You Apply
An IPO does not appear overnight.
A company preparing to go public has to complete several regulatory and listing steps. It prepares an offer document containing information about the business, its financial position, risks, promoters, use of funds and other relevant matters.
The company files a draft offer document, commonly called the Draft Red Herring Prospectus or DRHP, as part of the IPO process.
The stock exchange also carries out its own listing-related checks. The company has to meet applicable requirements before its securities can be listed.
The final offer document contains the information investors need to examine before applying.
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DRHP, RHP And Prospectus: What Do These Mean?
The names can sound complicated, but the idea is fairly simple.
DRHP: Draft Red Herring Prospectus. This is an early version of the offer document filed during the IPO preparation process.
RHP: Red Herring Prospectus. This is the offer document used before the final issue price is determined in a book-built issue.
Prospectus: The final legal offer document containing the relevant details of the issue.
These documents can tell investors what the company does, how it makes money, its financial performance, the risks it faces, how it plans to use the money raised and details about the issue.
That is why reading the offer documents matters before applying.
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How Is The IPO Price Decided?
This is where book building comes in.
In a book-built IPO, the company sets a price range rather than one final price at the beginning.
Investors submit bids within the specified price range. The demand received at different prices helps determine the final issue price.
For example, imagine an IPO has a price band of Rs. 100 to Rs. 110.
An investor may bid at Rs. 110, while another may bid at Rs. 105.
After the bidding period closes, the final issue price is determined through the applicable price discovery process.
This is different from a fixed-price issue, where the issue price is specified in advance.
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What Is A Lot In An IPO?
You usually do not apply for just one share.
An IPO specifies a lot size, which tells investors the minimum number of shares that can be applied for in one lot.
Suppose an IPO has a lot size of 50 shares and the issue price is Rs. 200 per share.
One lot would then cost Rs. 10,000.
An investor applying for two lots would bid for 100 shares, subject to the rules and categories applicable to that issue.
The actual lot size and minimum application amount vary from one IPO to another.
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Who Can Apply?
IPO allocations are divided into categories under the applicable rules.
These can include institutional investors, non-institutional investors and individual investors, along with other categories where applicable.
The exact allocation rules can vary depending on the type of issue.
For individual investors, the amount they apply for and the applicable issue rules determine the category in which their application falls.
So, do not assume that every IPO follows exactly the same allocation structure.
How Do You Apply For An IPO?
The process is largely digital for individual investors.
You generally need a PAN, demat account, bank account and a permitted payment mechanism.
For UPI-based applications, the investor enters their UPI ID while applying. A request is then sent to approve the blocking of funds.
The money is blocked, not immediately transferred to the company.
This is known as ASBA, or Application Supported by Blocked Amount.
If shares are allotted, the required amount is debited.
If you receive fewer shares than you applied for, the amount relating to the unallotted shares is released.
If you receive no shares, the blocked amount is released according to the applicable process.
What Happens After You Apply?
The IPO closes after its bidding period.
The bids are then processed and the basis of allotment is finalised.
If demand exceeds the shares available in a particular category, an investor may receive fewer shares than they applied for or none at all, depending on the applicable allotment rules.
After allotment, shares are credited to successful applicants' demat accounts.
The company then completes the listing process, after which the shares begin trading on the stock exchange.
Why Do IPOs Get Oversubscribed?
You may have seen headlines saying an IPO was subscribed several times over.
Suppose an IPO has shares worth Rs. 100 crore available for a particular category, but investors submit valid bids worth Rs. 500 crore.
The issue has then received demand equal to five times the amount available in that category.
That is called 5x subscription.
But high subscription does not automatically mean every applicant will receive shares. In an oversubscribed category, allotment depends on the rules applicable to that issue.
What Happens On Listing Day?
Listing day is when the company's shares become available for trading on the stock exchange.
The market price can be above, below or around the IPO issue price.
For example, if the IPO issue price is Rs. 200, the share might start trading at Rs. 240, Rs. 190 or another market-determined price.
The IPO price is not a guarantee of the price at which the share will trade after listing.
This is also why a listing gain should not be treated as a certainty.
Why Does An IPO Matter To Investors?
An IPO gives investors an opportunity to become shareholders in a company as it enters the public market.
But the opportunity comes with risk.
A company can have a strong business and still see its share price fall after listing. Market conditions, company performance, competition, valuation, economic changes and investor sentiment can all affect the share price.
SEBI specifically advises investors to understand the risks, read the relevant documents and avoid making decisions based on rumours or promises of quick returns.
What Should You Check Before Applying?
Before looking at whether an IPO is generating buzz, look at the company itself.
Check:
What does the company actually do?
How does it make money?
Is revenue growing?
Is the company profitable?
What does its cash flow look like?
Does it have significant debt?
Why is it raising money?
How much of the issue is a fresh issue and how much is an OFS?
What risks has the company disclosed?
Who are its promoters?
How does its valuation compare with relevant listed companies?
The answers are available, to varying degrees, in the company's offer documents and financial disclosures.
SEBI's investor guidance also recommends examining the business model, financial health, competitors, valuation and risk-return profile before investing.
IPO Vs Buying Shares Normally
The simplest difference is where the shares come from.
When you apply for an IPO, you participate in the primary issue.
When you buy a listed company's shares from another investor on a stock exchange, you are participating in the secondary market.
An IPO also has an application period and an allotment process.
A listed share can generally be bought or sold during market hours when the exchange is open and the security is available for trading.
Does Every IPO Make Money?
No.
There is no guaranteed return from an IPO.
A share can list above its issue price, below it or move in either direction after listing.
Even if an IPO receives heavy subscription, that does not guarantee a profit for investors.
SEBI warns investors against relying on promises of high or guaranteed returns and advises them to understand the risks before investing.
The Bottom Line
An IPO is a company's route from the private market to the public market.
For the company, it can be a way to raise capital and bring its shares to the stock exchange.
For investors, it can be a chance to become shareholders through the primary market.
But the IPO application itself is only the beginning. Understanding the company's business, offer documents, pricing, risks and allotment process is just as important as knowing how to press the 'Apply' button.
TL;DR | News At a Glance
What is an IPO?
An IPO, or Initial Public Offering, is when a company offers its shares to the public for the first time and seeks to list them on a stock exchange.
Why do companies launch IPOs?
Companies can raise money through a fresh issue of shares, while an Offer for Sale allows existing shareholders to sell their shares.
How does an IPO work?
Investors apply during the IPO's bidding period. The final price is determined according to the issue's pricing method, followed by allotment and listing.
What happens to the money when you apply?
Under ASBA, the required amount is blocked in your bank account. It is debited if shares are allotted, while the amount for unallotted shares is released.
What is IPO allotment?
It is the process of deciding how many shares each successful applicant receives after the IPO closes.
What happens after allotment?
The shares are credited to investors' demat accounts and then listed for trading on the stock exchange.
Can an IPO guarantee profits?
No. A stock can list above, below or around its IPO price, and its market value can change after listing.
