What Is an IPO? A Complete Beginner’s Guide to Initial Public Offerings.
Assume a case in which the bakery you love in your town wishes to expand its operations nationwide. To finance such an effort, the owners need quite a lot of money. In that case, they could get a large loan from the bank, but they could also desire investments from residents through small stakes in their business.
When a company decides to offer its stock for sale to the general public for the very first time, it is called an Initial Public Offering, also known as an IPO. It is a huge financial step that completely changes the working style of the business and creates some wonderful money-making opportunities for ordinary investors.
In this simple guide, we will explain to you what an IPO is and how it can be invested in.
What Is an IPO?
The concept of an IPO can be explained as follows: an Initial Public Offering is the official process where a privately owned company lists its shares on a public stock exchange, allowing anyone to buy a piece of the business.
Before the case of the IPO, the company is a private company, which means that the ownership of the company lies in the hands of its owners, initial employees, and key stakeholders. Once the IPO comes into effect, the company becomes “publicly held“.
This means regular everyday people can buy and sell those shares freely on stock exchanges like the NSE, BSE, or NASDAQ.
How Does an IPO Work?
Going public is a lengthy legal process; however, the major stages are quite simple:
- Investment Bank Recruitment: The business hires specialized banks (known as underwriters) to handle the legal documents and help figure out how much the company is worth.
- Regulatory Approval: The firm gives its financial information to market regulatory bodies (such as SEBI or SEC) to check whether all processes are legal.
- Fixing the Price: The corporation, along with the bank, decides on the price range for the shares according to the willingness shown by the investors.
- Bid Window Opening: The bid window is opened for some time period, which allows the investors to submit bids for purchasing shares in packages called lots.
- Listed Trading: The shares are distributed to the investors, and the listing of the stock starts officially.
Why Do Companies Launch an IPO?
- For Large Capital Generation: Selling shares gets massive amounts of cash to build factories, launch new products, or pay off company debts.
- For Increasing Credibility: Passing through strict government inspection makes the firm seem credible and trustworthy among customers and business partners.
- Exit Strategy for Early Investors: The early investors are allowed to sell their shares and make returns on their investment.
Types of IPOs
Companies may choose between the two methods described below when deciding the share price:
- Fixed price IPO: This is where the company gives the price per share at the start of the bidding process.
- Book building IPO: This is where the company puts up a price range (e.g., $90-$95), and the investors then bid what they are ready to pay. The price will be set based on demand.
You might also hear about Mainboard IPOs (for giant, established corporations) and SME IPOs (tailored for small and medium enterprises).
Who Can Invest and What Do You Require?
Investment in an IPO is open to anyone, but there are certain groups of investors represented by the market to provide a level playing field:
- Retail Individual Investors (RIIs): Regular people like you and me who invest smaller amounts of money.
- High Net-worth Individuals (HNIs): Wealthy citizens making huge financial bids.
- Qualified Institutional Buyers (QIBs): Financial institutions including banks and insurance companies.
The Beginner’s Checklist
There are only four important conditions that are needed in order to apply for an IPO.
- Valid Tax ID: Similar to a PAN card, which is compulsory for record-keeping.
- Bank Account: So that your account and funds can be blocked for your application.
- Trading Account: For bidding in the stock exchange market.
- Demat Account: A digital locker to hold your allotted stocks safely.
How to Apply for an IPO Step-by-Step?
- Open up your best stockbroker application or online net banking website.
- Jump directly into the investments or IPOs segment and choose the company whose IPO you plan to buy.
- Simply enter the number of lots of shares that you would like to purchase along with your bid amount.
- Submit your bid and authorize your UPI request in the respective apps or banking portals.
- Using the ASBA process, your bank will lock up the application amount in your account, which does not leave your account until you get assigned those shares.
Understanding the IPO Timeline
Opening & Closing Dates: You have only a limited 3-to-5 days to apply.
Allotment Day: The day when the company assigns shares to lucky applicants. In case of oversubscription, a lottery decides the lucky ones.
Listing Day: The great day when the stocks start trading live. If the stock lists at a price higher than your allotted price, then you earn listing gains.
Risks vs. Advantages of IPO Investing
First, one will get a chance to invest at the early stages of development of the growing company, thus potentially earning huge money in the future.
Still, there are some risks one should consider carefully. Young companies are not yet listed for a long time, so their prices can fall once the buzz goes away.
IPO vs. FPO vs. Direct Listing
An Initial Public Offering (IPO) is the first-ever allocation of stocks by any company. Follow-On Public Offering (FPO) comes into the picture when a company, which is already listed, requires additional funds and makes an issuance of additional shares.
Direct Listing happens when a company is listed on the stock exchange without issuing any new shares and avoiding the cost of investment banks.
How to Check if an IPO Is Good or Bad?
Never invest in an IPO based on its social media performance. It is always better to download the Red Herring Prospectus (RHP) from the website of the company. Examine the areas in which they are going to use the money they raised through the IPO process.
Check whether they are having continued growth in revenue and low debts. Also, check the background of their management.
FAQ
- What is an IPO?
It means when a privately held company offers its stocks to the public for the first time ever on the stock exchange.
- What will be the investment amount?
You will have to purchase a minimum number of stocks called a lot, which is priced anywhere between $150 and $200 (₹15,000 in India).
- Is it secure to invest in an IPO?
There are risks involved in stock trading, and even IPOs are extremely volatile and fall steeply if they are overvalued.
- What will be the situation in case I am unable to receive the shares?
In case an IPO is oversubscribed and your allotment is missed, your blocked money will be released within days.
Key Takeaways
- Ground Floor Access: Investing through IPOs means getting the opportunity to invest in large and successful firms right from the start.
- Secured Transaction Process: With the help of the ASBA procedure, your money is safely stored in your bank account until the shares reach you.
- Research Rather Than Hype: Never depend on the hype around any business; always study its financial history.
Conclusion
An IPO is an important event that enables companies to develop into world leaders. In your case, an IPO gives you a fantastic chance to create yourself a fortune by dealing with growing companies.
However, a sound investment strategy cannot be developed without a cool head. With the help of actual financial data analysis rather than propaganda tricks, you will be able to save your funds and invest wisely.
It takes time to study some basics and then use your knowledge to determine a great company from the current hype.
