Know what is an IPO in the stock market? Its 10 amazing facts and understand how it works. Must read before investing in the share market.
Introduction: What is IPO and why is it so important?
If you have ever thought about investing in the stock market, you must have heard the name of IPO. This term often remains in the headlines when a big company is about to go public. But in reality, what is an IPO in the stock market? And why is it so crucial?
IPO, i.e. Initial Public Offering, is the first step when a private company lists its shares in public. It means that now any common investor can become a part of that company. This is not only a great opportunity for the company, but also for the investors. In this blog post, we will explore 10 such important facts about IPO which will explain everything to you about it, in simple Hinglish! So let’s start this exciting journey.
What Is An IPO in The Stock Market? And How It Works
First of all, it is important to understand what is an IPO in the stock market and how it works. IPO is a process in which a private company offers its shares to public investors for the first time. This gets the company listed on the stock exchange and its shares become available for buying and selling.
How It Works?
When a private company seeks funding for growth or to reduce debt, it raises capital through IPO. In this process, the company hires one or more investment banks (called underwriters). These banks evaluate the company, determine the share price, and help sell shares to investors. When the shares are officially listed on the stock exchange, the public can trade them.
1. History of IPOs: A Brief Overview
The concept of IPO is quite old. The first recorded IPO in the world was in 1602 when the Dutch East India Company issued shares. In India too, the IPO market has seen a lot of growth in the last few decades. Earlier it was limited to large industrial houses, but now tech startups and new businesses are also taking the IPO route. Digitalisation and increased investor awareness have increased retail participation in the IPO market. For example, the number of Demat accounts in India has increased from 40 million in 2020 to more than 175 million in 2024, which shows the increasing interest of retail investors
2. What Is the Purpose of an Initial Public Offering?
Why does a company do an IPO? What Is the Purpose of an Initial Public Offering? There can be many reasons for this:
Raising capital: The company needs funding for big projects, business expansion, or debt repayment. This capital is obtained from the IPO.
Liquidity: IPO gives existing shareholders (such as founders, early investors) a chance to convert their investments into cash.
Visibility and Prestige: Becoming a public company increases the company’s brand value and market visibility. It makes it easier to attract talent and secure business deals.
Acquisitions: By being listed on the stock exchange, the company can use its shares to acquire other companies.
Why Would a Company Do an IPO?
Doing an IPO is a strategic move for a company. It is a milestone that reflects the company’s growth and maturity. It also provides the company with a platform for future funding, such as Follow-on Public Offerings (FPOs) or debt issuance.
3. IPO Process: Step-by-Step Guide
The IPO process can be a little complex, but here is a simple breakdown:
Investment Bank Selection: The company selects one or more investment banks (underwriters).
Draft Red Herring Prospectus (DRHP) Filing: Underwriters prepare the DRHP, which contains all the financial and operational details of the company. This document is submitted to SEBI (Securities and Exchange Board of India).
SEBI Approval: SEBI reviews the DRHP and may give some observations. After addressing the objections, SEBI gives final approval.
Roadshow: Company management and underwriters make a presentation of the company in front of potential institutional investors (such as mutual funds, foreign institutional investors), which is called a roadshow. This creates demand.
Price Band Fixing: The company decides the price range of the shares (floor price and cap price).
Subscription Period: Investors bid for IPO shares during this period. There is also a reserved quota for retail investors.
Allotment: After the IPO closes, shares are allocated to successful bidders. If there is oversubscription, shares are allocated on a pro-rata basis.
Listing: Finally, the shares are listed on the stock exchange, and trading begins. SEBI has now reduced the listing time from T+6 days to T+3 days, thereby making the process faster (Source: Angel One).
4. How Does An IPO Work For Investors?
To participate in IPO for investors, it is necessary to have a Demat and Trading account. You can apply for IPO through your broker or use ASBA (Application Supported by Blocked Amount) facility. In ASBA, money from your bank account remains blocked until shares are allocated. If shares are not allotted, the money is automatically unblocked.
- Risk and Reward: IPOs have the potential of high returns, especially if the fundamentals of the company are strong. But there is also high risk if market sentiment is not good or the company’s performance is lower than expectations.
- Subscription: It is important to see how much the IPO was subscribed. High subscription means high demand, which can increase the chances of listing gains.
5. Types of IPO: Which are these?
IPOs are mainly of two types:
- Fixed Price Issue: In this the company decides the price of the shares in advance. Investors have to buy the shares at that price.
- Book Building Issue: This is more common. In this the company gives a price band (like ₹100-₹110). Investors bid at their preferred price within this band. The final ‘cut-off’ price is decided according to the demand.
6. IPO Advantages and Disadvantages
Like every investment, IPOs also have their advantages and disadvantages:
Advantages :
- Listing Gains: If market sentiment is positive and demand for the IPO is good, then shares can open at a higher price on the day of listing, giving investors instant profit. In 2024, almost 75% of IPOs have given positive listing returns (Source: Livemint).
- Early Entry: Investors get an early entry into a growing company.
- Diversification: IPOs can be a way to diversify your investment portfolio.
Disadvantages :
- Volatility: Share prices can be quite volatile after the IPO.
- Overvaluation: Sometimes companies can overvalue their IPO, which can reduce listing gains or even lead to losses.
- Lack of History: Being a new public company, its financial history is limited in the stock market, which can be difficult to research.
7. Performance of IPOs: Are they always beneficial?
Performance of IPOs varies. Some IPOs give tremendous listing gains, like Hyundai Motor India IPO which was India’s biggest IPO in 2024 (₹27,870 crore) (Source: Livemint). However, some IPOs do not meet expectations.
- Market Conditions: Overall stock market sentiments have a big impact on IPO performance. IPOs are more successful in bull markets.
- Company Fundamentals: Company’s financial health, management quality, and industry outlook are also important factors.
- Pricing: If the pricing of the IPO is fair then the chances of being successful increase.
According to a statistic, 2024 was a record-breaking year for IPOs in India, with capital raised of $20.5 billion (approx ₹1.6 lakh crore), making it the second largest market after the US (Source: KPMG).
8. IPO Alternatives: What are the other options?
If you are unable to invest in IPO or you feel the risk is too high, then IPO alternatives are also available:
- Existing Listed Stocks: You can invest in shares of companies already listed on the stock exchange. Here you easily get the company’s past performance and market history.
- Mutual Funds: You can indirectly invest in IPOs through Mutual Funds, because some funds participate in IPOs.
- Private Equity/Venture Capital: These options are for high-net-worth individuals and institutional investors who want to invest in unlisted companies, before IPO.
9. Is It Good to Buy at IPO?
Is It Good to Buy at IPO? This is a million-dollar question! There is no straight answer to this. It depends on your risk tolerance, research, and market conditions.
- Pros: If the company is fundamentally strong and the IPO pricing is reasonable, then listing provides an opportunity for gains.
- Cons: Chances of shares being allotted may be reduced due to over-subscription. The price of shares may also fall after listing.
- Research is Key: Before applying for IPO, read the DRHP of the company thoroughly, analyze its financials, management, and future prospects.
10. Terms Associated with IPO: Important Terminology
There are some common terms in IPO investment that are important to understand:
1. Underwriter: Investment bank that manages the IPO process.
2. Red Herring Prospectus (RHP): Final document submitted to SEBI before IPO, which contains issue details but not the price.
3. Draft Red Herring Prospectus (DRHP): Draft version of RHP that is submitted to SEBI for approval.
4. Anchor Investor: Large institutional investors who commit to buy substantial shares before the IPO opens. There are now stricter lock-in rules for them (50% shares locked-in for 90 days, Source: m.Stock).
5. Lot Size: Minimum number of shares you can buy in an IPO.
6. Cut-off Price: The final share price in a book building issue which is decided after bidding.
7. Listing Day: The day the shares officially start trading on the stock exchange.
Conclusion: IPO Investment – A Calculated Move
So now you must have understood well what is an IPO in the stock market? and the important things around it. IPO can be an exciting opportunity to grow your investment portfolio, but it also comes with high risk. Always do your research, understand the fundamentals of the company, and analyze market trends. Never invest based on hype. Smart investments only benefit you in the long term.
Are you also thinking of investing in IPOs? Then why delay! Open your Demat account today and be a part of this exciting journey of the stock market. But remember, always invest according to your financial goals and risk tolerance. Happy Investing!
FAQ (Frequently Asked Questions)
1. Why Would a Company Do an IPO?
A company primarily does an IPO to raise capital so that the business can be expanded, debt can be reduced, or money can be invested in research and development. This provides liquidity to existing shareholders and also improves the company’s public image and credibility.
2. Is It Good to Buy at IPO?
Whether buying in an IPO is “good” or “bad” depends on how strong the fundamentals of the company are, the pricing of the IPO, and the overall market conditions. If the research is good and the company has growth potential, listing may provide an opportunity for gains. But if it is overvalued, there may be losses as well.
3. Can Anybody Invest in an IPO?
Yes, anyone who has a Demat and Trading account can invest in IPO. A fixed quota (usually 35%) is reserved in IPOs for retail individual investors.
4. Who Gets the Money From an IPO?
The money raised through IPO primarily goes to the company. The company uses this money for its business (fresh issue of shares). Sometimes, existing shareholders (like promoters or early investors) also sell their shares (Offer for Sale – OFS), in that case that money goes to those shareholders.
5. Is an IPO a Good Investment?
An IPO can be a high-risk, high-reward investment. Some IPOs have provided substantial returns to investors, while others have caused losses. This depends on the company’s business model, financial health, management, and market sentiment. For diversification and the potential for long-term growth, it may be a good idea to make IPOs a small part of your portfolio.
6. How Is an IPO Priced?
IPO can be priced in two ways:
Fixed Price Issue: The company decides a fixed price for the shares in advance.
Book Building Issue: In this the company gives a price band (minimum and maximum price). Investors bid within this band, and the final ‘cut-off’ price is decided on the basis of demand-supply. Underwriters play an important role in this process.