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An initial public offering (IPO) is the procedure of releasing fresh shares of stock to the public for the first time in a private firm. A corporation can raise equity funding from the general public through an IPO.
Since there is often a share premium for present private investors, the transition from a private to a public firm can be a crucial period for private investors to completely realize rewards from their investment. Additionally, it enables public investors to take part in the sale. In this article, you'll go understand IPO meaning and how it works.
What is IPO: Meaning and Definition
Initial Public Offering, or IPO, is a unique process to convert a private company into a public company by issuing shares. The issuance of shares for the public allows the company to gather capital and an excellent opportunity for the general public to invest and earn returns on that investment.
Initially, a private company grows with its initial investors, founders, and stakeholders. When a company has achieved a specific goal where the management realises that they are stable enough to handle the SEC (Securities And Exchange Commission) regulations, grow and diversify using the general public's money, the company decides to offer an Initial Public Offering. Through this, the stake-holdership in the company is offered to the general public through shares.
How does an Initial Public Offering Work?
A company typically launches an IPO to raise money for the future, enable simple asset trading, increase equity capital, or monetize existing stakeholder investments.
Institutional investors and the general public can assess the information in the prospectus about the initial sale of shares. The extensive prospectus contains comprehensive information about the proposed offerings.
The listed stock is ready for trading after the IPO announcement. The stock exchange determines the minimum free float requirement for shares in absolute terms and as a percentage of the total share capital.
About IPO - Primary & Secondary Market
Primary Market is where the company sells fresh stocks like IPO. This is the first instance where the investors contribute to the company, and the company's equity capital is made by funds accumulated by selling stocks in the primary market. Private placement and preferential allotment are two other ways in which stocks can be sold in the primary market after an IPO. In private placement, the company can offer stock to significant investors like banks, hedge funds. This could be done without making the shares available for the general public. In preferential allotment, the company can sell shares to select investors at a price which is not available in the market
Secondary Market is commonly known as a stock exchange. This is where the stocks that have been allocated in the primary market are resold and purchased further by new people. A secondary market is where the investors trade among themselves.
Types of IPO
There are two types of IPOs. They are dependent upon the type of price generation the company or the underwriter is going for. These are of two types:
In Fixed Price Offering, the company decides on the price of the stocks initially, and any buyer or investor pays that amount per share to obtain the desired number of stocks.
In Book Building IPO, the company decides the price band of the forthcoming IPO where the floor price is the minimum, and the cap price is the maximum, and the bidding is done within this range. The price is set by the underwriter and the company's investors with surveys done on what would be the value of the share. The bids are made, and the selected investors get the stocks.
Why are IPOs generated? What is the need for launching IPOs?
There are only two reasons due to which a company issues an IPO. It is to raise capital or return money to the initial investors.
The company opens itself to public investors by releasing an IPO. The IPOs give them a greater domain for the amount of investment. They can raise much more money than they could ever raise by the private investors.
One other reason the company considers releasing an IPO in the future is that it attracts initial investors. The investors have an option to sell their stocks in the company and get a return on their initial investment.
Types of Investors
Investors are classified into three major categories. They include the following:
Qualified Institutional Buyers (QIB): These are big investment firms, mutual funds, a scheduled commercial bank, along with a few other institutions that have been registered with SEBI. Not more than 50% of the securities are reserved for this category in a case of book-built issue, minimum 75% of the securities in case of compulsory book-built issue and
Retail Individual Investor (RII): These are individual investors who apply or place bids for shares with a cumulative value not exceeding 2 lakh rupees. At least 35% of shares are allocated in this category in case of book-built issue and not more than 10% are allocated in case of compulsory book-built issue. At least 50% shares are allocated in case of fixed price issue.
Non-Institutional Investors: These are investors other than QIB and Retail investors. These include High Net worth Individuals (HNI) or corporate bodies. At least 15% of stocks are reserved for this section of investors in case of a book-built issue and not more than 15% in case of compulsory book-built issue.
Advantages of an IPO
IPOs are a key formula to generate or raise capital. Here are some additional advantages that IPOs bring:
● An IPO enables the public to invest in a potential project or business.
● IPOs make acquiring companies simpler.
● They boost visibility and reputation.
● They facilitate increased transparency due to the requirement for quarterly reporting.
● Companies that launch an IPO are granted more conducive credit borrowing conditions than any other private company.
Initial Public Offering (IPO) is currently one of the most popular investment models for people. Anyone with sufficient knowledge of the stocks and their in-depth operations can garner huge profits from the stock market.
How to check for upcoming IPOs?
Investors interested in allocating their money to IPOs can stay updated about the upcoming IPOs through various means. These means include the following:
- They can check the stock exchange websites and get news about the upcoming IPOs. Many stock exchanges have a dedicated section of IPOs where desiring investors can get information about the upcoming IPOs. These websites, in various cases, also provide the IPO calendar and the IPO prospectus.
- Another mode is various websites on the internet. Those websites will provide you with authentic news under the segments such as "new ipos" or "ipo list."
- The third avenue is to look on the official website of aggregators, brokers, stock market information websites, blogs, and so on. Discount brokers like 5paisa.com. provide the investors with complete information and analysis of the upcoming IPOs. You can check the IPO section on our website OR in our mobile trading app.
What is the IPO Timeline?
The process of applying for an IPO and getting it allocated to your name with various procedures in between is known as the IPO timeline. The process, also known as the IPO calendar, has the following subdivisions:
- Open/Close Date: These are the opening dates and closing dates of the bidding process in IPOs. Any desiring bidders can apply or bid between these days.
- Allotment Date: Allotment date is when the allotment status is announced to the public by the registrar of the IPO.
- Refund Date: The application amount is frozen, and you cannot withdraw the amount you used to apply for the IPO. Based on the IPO's allocation, the date on which the refund is initiated for the people who didn’t get the IPO, is known as the refund date.
- Credit to Demat Account Date: This is different for different companies, but this is when you receive the credit of the applied IPO shares in your Demat account before the listing date of the shares of the company.
- Listing Date: It is also known as IPO listing.This is when the shares of a company are officially listed on the respective stock exchanges (secondary market) and available for trading.
- Issuer: Issuer of an IPO is the company that issues the stocks to raise capital.
- Underwriter: Underwriter is a banker, financial institution, or broker who helps the company underwrite the IPO. These act as a broker medium between the public and the issuer.
- DRHP: It stands for Draft Red Herring Prospectus, also known as the offer document. It is a preliminary registration document prepared by the Investment bankers for the IPO issuing company in case of a book built issue. the document contains the financial and operational information of the company along with a few other information like why it is attempting to raise money.
- RHP: Red Herring Prospectus is the preliminary registration document that is filed with SEBI in a case of book built issue. It doesn’t contain the number of shares or the price of the shares being offered in an issue.
- Price Band: A price band is basically the lower price and the upper price per share with which the company would go public.
- Issue Size: The Issue size in an IPO means the number of shares issues multiplied by the amount of each share.
- Under Subscription: This is a condition when the number of shares applied by the public is less than the number of shares issued by the company.
- Oversubscription: This is a condition when a company receives more applications than the number of shares being offered by the public.
Things to remember while investing in an IPO
Investing in an IPO is usually a beneficial option, but before investing, you should keep the following things in mind:
- Study the company, its background, financials, future aspects before you invest in the IPO.
- Note the IPO locking Period. The locking period is a duration in which you cannot sell or trade the stocks after an initial investment.
- Always plan an investment strategy before investing in any IPO.
More About IPO
Frequently Asked Questions
Most investors consider IPOs a good investment due to the media hype and the subsequent fluctuation in price that often leads to higher gains. However, earning profits is not a confirmed outcome of an IPO. Therefore, it is essential to analyse the company’s prospectus with its financial position and risk tolerance.
When a company decides to go public through an IPO, they need to list the initial value of its shares. The underwriting banks fulfil this process. The company’s fundamentals and growth prospects determine its stock’s value. However, supply and demand play an equally crucial role in the IPO price.
While the terms stock and share are used interchangeably, an IPO is when a company sells shares of its stock.
The IPO profit is essentially the percentage gain on your investment. Therefore, to determine your profit or loss, divide the investment amount by the share’s purchase price.