Before understanding the process of IPO, it is essential for any investor to understand what exactly is an IPO. The Initial Public Offering (IPO) is a very important point at which an unlisted company decides to go public for the first time by publicly listing its shares and selling its stocks to the investors. It is an offer of shares typically made to raise capital for the company.
The main aim of an IPO is to raise funds from public investors. It also enhances the credibility and brand value of the company. Apart from raising funds for growth, some companies may announce an IPO to clear off company debts.
Prior to an IPO, a company is considered private, and the shares are considered to be under private share ownership. Once a company lists its shares, all private share ownerships are converted to public ownership. The previously private shareowners can sell their shares as per the listed pricing. Overall, IPO strengthens the company base by involving the public in its growth.
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Process of IPO
The process of IPO is detailed and involves a few predefined steps. It includes multiple stages starting from the selection of Investment Bank to company listing. The following section explains the process in details:
- Step 1- Selection of an Investment Bank:
When a company decides to go public, it needs to hire an investment bank. These banks act as market intermediary in the process of company listing. The Investment bank goes through the company's financial statements and evaluates the worth and risks of the company. The Investment bank also assumes all responsibilities and creates a prospectus for prospective investors. It is the task of the Investment bank to generate initial buzz for an IPO.
- Step 2- Preparing DRHP for SEBI Approval:
After conducting due diligence, the investment bank and the company create the registration statement and the Draft Red Herring Prospectus (DRHP) to submit to SEBI. The DRHP contains all the information about the business except the price or quantity of shares being offered.
The regulator at SEBI verifies the facts shared by the company and checks for errors. If SEBI asks for changes, the issuer must submit that back to SEBI. After all the changes are approved in the application, SEBI approves the draft prospectus. The issuer and underwriter then use the approved prospectus to promote the IPO.
- Step 3-Roadshow:
In this stage, the company announces its decision to go public. For maximum reach, investment bankers and underwriters try their best to travel to all possible financial institutions worldwide. Roadshows aid in convincing investors about the company’s potential. The company executives and underwriters can conduct Q&A sessions and multimedia presentations for sharing details of IPO and the company.
- Step 4- Application to Stock Exchange:
After getting SEBI’s approval, the company files an updated prospectus called the Red Herring Prospectus (RHP). However, the RHP does not include the price of the IPO.
- Step 5- Pricing of Shares:
Determining the price and the number of shares is an essential step of IPO, and it is generally done a few days before company listing. When deciding the pricing of shares, companies choose either of the two following methods-
Fixed price IPO: In this case, the companies offer a fixed price of a share. If companies decide to issue their share at a fixed price, the same is mentioned in the draft prospectus as well as the final prospectus, which has been approved by SEBI.
Book building IPO: When the company does not want to offer the shares at a fixed price, it can set the upper and lower limit for the bidding process. A Red Herring Prospectus contain this price band. It is a document that contains details of the issuing company except for the effective date and offer price.
- Step 6- Public Purchase
Once the company has selected the type of IPO, they want to issue, and the shares are made public. After the interested investors apply for the shares, the company can then allot them accordingly.
Also Read: IPO Application Eligibility
What happens Later?
After shares have been sold post IPO, the major shareholders and insiders are restricted from selling their shares. This phase is known as the Lock-Up period in an IPO. During the Lock-Up period, the company insiders and early investors cannot sell their shares, thereby preventing overwhelming the market with excess shares. This step ensures that the stock price does not decline from a sudden flood of selling. The length of this period ranges between 90 to 180 days.
IPO Lock-Up periods allow the newly issued shares to reach stability without additional pressure to sell shares from insiders. The period generally applies to insiders, including founders, owners and managers of the company, employees, and sometimes they may affect early investors like venture capitalists.
This period is also called the cooling-off period as it ensures the market allows the pricing of shares according to the natural rule of demand and supply. The liquidity can be low in the initial phase, but it may increase with time.
The joint effort of the companies, along with the underwriting banks, can use the lock-up period as a means to boost the share price in the IPO. This phase can also let the companies retain key employees. It also guarantees that the insiders share the same result as the public investors.