What are Initial Public Offerings (IPOs)? An Investment Guide
If you are looking for a way to invest in the share market, an Initial Public Offering (IPO) can be an attractive option. But before investing in IPOs, it is essential to understand their meaning, how they work, and the potential risks and rewards. In this guide, we’ll learn about IPOs, their objectives, the IPO investment process, and much more. Let’s begin.
What is an IPO?
An initial public offering (IPO) is the first time a company issues shares of its stock to the public, allowing it to raise capital. In other words, it’s a company’s first public sale of equity to investors. This allows the company to raise capital from a broader range of investors than it could through private investments.
Why Do Companies Launch an IPO?
Companies launch IPOs to raise capital, fund growth initiatives, repay debt, and reward early investors and employees who hold stock in the company.
How Does an IPO Work?
A company is considered private before an IPO. As a pre-IPO private entity, the business has developed with a relatively limited shareholder base, including early investors like founders, family, and friends and professional investors such as venture capitalists or angel investors.
An IPO of company marks a significant milestone with access to raising a lot of money. Additionally, the heightened transparency and credibility associated with being listed on the stock market can contribute to securing more favourable terms when seeking external financing.
History of IPOs
The history of Initial Public Offerings (IPOs) traces back to ancient Rome when the government sold shares of public assets to raise funds. However, the modern concept of IPOs evolved in the late Middle Ages and Renaissance periods, when European companies sought additional capital by issuing shares to the public. The first company to issue shares on a public stock exchange was the Dutch East India Company in 1602.
In the United States, the Buttonwood Agreement of 1792 marked the beginning of organized securities trading in New York City. The agreement laid the foundation for the New York Stock Exchange (NYSE), and companies gradually started going public to raise capital.
Initial public offerings (IPOs) became a major method for companies to access public capital markets during the 20th century. The late 1990s and early 2000s dot-com boom saw a surge in technology-related IPOs, with many internet-based companies going public.
Key Initial Public Offering (IPO) Terms To Check
Let’s have a look at the key IPO terms that you must know.
| Term | Description | Importance |
|---|---|---|
| Offer Price | The final price per share determined after the process of IPO in India. | Crucial for evaluating potential return and risk. |
| Issue Size | Total value of shares being offered in the IPO. | Indicates fundraising amount and company valuation. |
| Book Building | Process where investors submit bids and the final price is determined based on demand. | Provides insight into investor enthusiasm and potential market performance. |
| Lock-up Period | Restriction on insiders like founders and early investors from selling shares after the IPO. | Implies confidence in the company’s future and can stabilize the stock price. |
| Underwriter | Third parties such as banker or broker hired by the company to assist. | Generally determines the issue price, publicizes the IPO and allocates shares to investors. |
| DRHP | DRHP stands for Draft Red Herring Prospectus. | Crucial document in the Initial Public Offering (IPO) process, serving as the first official document a company files with regulatory authorities like SEBI (India) or SEC (US) when they intend to raise capital through an IPO. |
What are the Different Types of IPOs (Initial Public Offerings)?
There are several types of Initial Public Offerings (IPOs) with different characteristics and requirements. Some of the most common IPO types include:
- Traditional IPOs: This is the most common type of IPO in the share market. The company hires an investment bank to underwrite the offering. The shares are then sold to institutional investors and the public.
- Direct Listing: A direct IPO listing is when a company lists its shares on an exchange without using an underwriter or selling new shares. Instead, existing shareholders can sell their shares directly to the public.
- SPAC IPOs: A Special Purpose Acquisition Company (SPAC) is a shell company formed to merge with or acquire another company. SPAC IPOs are becoming increasingly popular as a way for private companies to go public.
- Secondary IPOs or FPO: This type of IPO is when a company already public issues new shares to raise additional capital.
- Fixed Price IPOs: This involves a predetermined price at which shares are sold to investors.
- Book Building IPOs: Book-building initial Public Offerings involve a price range that is determined through investor demand.
What is an IPO Timeline?
An IPO timeline outlines the key dates and events in a company’s initial public offering (IPO) process. Here’s a breakdown of the four key IPO dates:
| Event | Description |
|---|---|
| Open/Close Date | The period for submitting bids for the IPO shares. |
| Allotment Date | The date on which shares are allocated to successful bidders. |
| Refund Date | The date on which unsuccessful bidders receive a refund for their application money. |
| Credit and Demat Account Date | The date on which the allotted shares are credited to the demat accounts of successful bidders. |
What is the Eligibility Criteria to Invest in an IPO?
If you are planning to invest in an IPO, make sure you meet the eligibility criteria outlined below:
- Must hold a PAN card.
- Have a valid Demat account.
- Though a trading account isn’t required to invest in an IPO, it can be essential if you want to sell the share after it gets listed.
What is the Process to File an Initial Public Offering (IPO)?
Before investing in an IPO in share market, it’s important to understand the process. The IPO process typically consists of six stages:
- Pre-IPO Process: Before the initial public offerings, the company must prepare by ensuring that it meets all the necessary regulatory and legal requirements. This may involve conducting an audit, preparing financial statements, and creating a prospectus.
- IPO Filing: Once the company is ready to go public, it will file a registration statement with the Securities and Exchange Commission (SEC). This statement will include information about the company’s financials, management, and risks.
- Book Building: The underwriter is responsible for helping the company price and sell its shares. Thus, they will work with the company to determine the offering price and the number of shares to be sold.
- Roadshow: The roadshow is a marketing event where the company presents its business and financials to potential investors. This is an opportunity for the company to generate interest in the offering and attract investors.
- Pricing: The underwriter will set the final offering share price after the roadshow. This price will be based on market demand and the company’s financials.
- Trading: Once the shares are priced, they can be sold to the public. The shares will begin trading on a stock exchange, and their price will be determined by supply and demand. Thus, the IPO in the stock market is finally listed.
What are the Pros and Cons of Investing in IPOs?
Advantages of investing in Initial Public Offerings (IPO)
- Potential for High Returns: IPOs can offer investors the potential for significant gains if the company performs well after the IPO. Some IPO companies have seen IPO return on investment double or triple within the first year of going public.
- Opportunity to Invest in Promising Companies: IPO in share market may allow investors to invest in promising companies not yet available on the public market. This can be an opportunity to invest in the next big thing.
Disadvantages of investing in Initial Public Offerings
- High Risk: IPO investments can be considered high-risk. There’s no guarantee that the company will perform well after the IPO, and investors can lose their entire investment.
- Limited Information Available: Before an IPO, a company is not required to disclose as much information as a publicly traded company. This can make it difficult for investors to understand the company’s financials and operations fully.
- Short Track Record: Newly public IPO companies have a limited track record. Thus, this makes it difficult to evaluate their long-term prospects.
How to Invest in an Initial Public Offering (IPO)?
To apply for IPOs, investors are required by SEBI to abide by the following rules:
- In India, investors must be older than 18 to apply for an IPO.
- Investors interested in buying an IPO in India must have a working bank account with enough money.
- Any DP (Depository Participant) registered under Indian stock depositories must provide an investor with a Demat account.
- A trading account is also required to sell IPO shares.
- The bank account that is linked to the Demat account should support UPI and ASBA services as well as online banking.
- An investor must have a Permanent Account Number (PAN) to participate in an initial public offering.
IPO investments can have a complex process. Here are some simple steps you can follow.
- Research IPOs: Look for upcoming initial public offerings and read the prospectus to understand the company’s financials and operations.
- Open a Demat Account: You’ll need a Demat account to buy and sell shares in an IPO.
- Place an Order: You can order an IPO through your Demat account.
Who Can Invest in an IPO?
The investors are divided in three main categories:
1. Qualified Institutional Buyers (QIB)
- Mutual Funds
- Domestic Financial Institutions
- Foreign Institutional Investors
2. Non-Institutional Investors
- Corporates
- Investors other than retail investors
3. Retail Institutional Investors
What are the Steps to Withdraw or Delete an IPO Application?
Withdrawing or deleting an IPO application typically involves contacting your broker or intermediary and requesting a cancellation. Here’s are some simple steps you can follow:
- After contacting your broker, provide relevant information like name, application number, and other relevant information to help the broker identify.
- Mention the reason for the withdrawal if asked.
- Follow the instructions provided by the broker. Also, submit a written confirmation after filling out the withdrawal form.
- At last, confirm the withdrawal with your broker and preserve the confirmation.
How Does an IPO Differ from Regular Stock Market Investing?
- The Players
- Seller: In an IPO, successful bids result in the direct purchase of allotted securities from the issuing company. In standard stock investing, shares are bought from existing shareholders. You can also sell shares you already own.
- Intermediary: Unlike IPOs, regular stock trading involves using an intermediary agent, such as a stockbroker.
2. The Location
An IPO occurs on the primary market, marking the initial public offering of a company’s shares. While regular stock investments occur on the secondary market, where shares of already-traded companies are bought and sold.
3. The Costs
When you invest in an IPO, the price (or a price range) is fixed. The amount is mentioned in the company’s prospectus.
However, the values of non-IPO stocks vary with the supply and demand for them. Current trends, inflation, the company’s growth prospects, and many other factors play a role.
4. Assessment
To select an IPO, you should review its prospectus and read third-party reports about the company. Then, make your informed assessment. Since the company has not been publicly listed yet, it may not have the detailed statements maintained by public companies.
Tips for Investing in IPO
- Conduct Research: Do your due diligence and research the company before investing.
- Evaluate the Company’s Fundamentals: Look at the company’s financials and operations to evaluate its long-term prospects.
- Understand the Risks: Be aware of the risks associated with investing in Initial Public Offerings.
- Consider the valuation: Evaluate whether the company is overvalued or undervalued compared to its peers.
- Be Cautious of Hype: Don’t get caught up in the hype surrounding an IPO
Key Considerations for Investors Before Investing in an IPO
Investing in an Initial Public Offering can be a high-risk, high-reward proposition. Here are some key things to consider before investing:
- IPO Share Price: The IPO share price can be a good indicator of market demand for the shares. However, it’s important to remember that the share price can be volatile. Additionally, it may not reflect the true value of the company.
- IPO Investment: Investing in an IPO in business requires careful research and due diligence. Investors should review the company’s financials, management team, and industry trends before making a decision.
- IPO Share Price: The IPO share price can be a good indicator of market demand for the shares. However, it’s important to remember that the share price can be volatile. Additionally, it may not reflect the true value of the company.
- New Stock Listings: New IPO stock listings can be attractive to investors but also challenging. Before investing, it’s important to consider the company’s growth potential and the competitive landscape.
- IPO Companies: IPO companies are often high-growth, high-risk companies. Investors should be prepared for volatility and diversify their portfolios to mitigate risk.
To Wrap It Up…
Investing in Initial Public Offerings can be a lucrative opportunity for investors who understand the risks and do their due diligence. By following the tips outlined in this guide, and staying up-to-date on the latest IPOs, you can make informed decisions and potentially capitalize on promising new IPO stock listings.
FAQs
IPO means when a private company becomes public by selling shares for the first time, raising capital and increasing marketability.
The full form of IPO Initial Public Offering. It is typically written by one or more banks, who also arrange for the shares to be listed on stock exchanges.
IPO investment involves buying shares of a private company when it first goes public. It offers potential for high returns but also increased risk due to its limited track record.
Once allotted, your IPO shares are saved in the demat account. You can sell them at any time. However, like any stock, specify quantity, price, and order type on your trading platform. Remember, lock-in periods and market volatility may impact your options.
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