What is Initial Public Offering (IPO)?

Ravi started a tech company in his garage, using his savings to develop an innovative app that quickly gained popularity. As demand increased, Ravi needed more capital to scale up, so he borrowed from friends and family, accumulating loans and debt to hire developers and enhance his product. The company thrived, and its user base grew exponentially, but Ravi soon realized that traditional funding sources were no longer sufficient to support the next phase of growth.

Despite the rapid growth and success, Ravi faced a new challenge: he needed even more funds to take his company to the next level. Traditional loans and personal networks could no longer meet his financial needs. That's when Ravi decided to take a bold step and turn his private company into a public one by launching an Initial Public Offering (IPO).

But what exactly is an IPO?

IPO stands for Initial Public Offering, which is the process through which a private company offers shares to the public for the first time. This allows the company to raise new equity capital by selling a portion of its stake to investors.

The primary reasons for initiating an IPO include infusing new equity capital into the firm, facilitating the trading of existing assets, raising funds for future expansion, and monetizing investments made by existing stakeholders. During the IPO process, institutional investors, high net worth individuals (HNIs), and the general public gain access to the details of the first sale of shares through a document known as the prospectus. This prospectus provides comprehensive information about the proposed offering, including financial statements, business strategies, and potential risks.

Once the IPO is successfully completed, the company's shares are listed on a stock exchange and can be freely traded in the open market.

Types of an IPO

When a company decides to go public, it can choose between two common types of Initial Public Offerings (IPOs): Fixed Price Offering and Book Building Offering.

1. Fixed Price Offering:

In a Fixed Price IPO, the company sets a specific price for its shares during the initial sale. Investors are informed of this price beforehand and must pay the full amount when applying for shares. The demand for the stocks becomes apparent only after the issue is closed. This type of offering is straightforward, with the company determining the value of its shares based on its assessments and market conditions. Investors participating in a Fixed Price IPO know exactly what they will pay per share, providing clarity and simplicity in their investment decision.

2. Book Building Offering:

In contrast, a Book Building Offering involves a more dynamic pricing mechanism. Here, the company provides a price range known as the price band, which typically spans 20%. Interested investors place bids within this range, specifying the number of shares they wish to purchase and the price they are willing to pay. The lowest price within the range is referred to as the floor price, while the highest is the cap price. The final price of the shares is determined based on the bids received, aligning the offering price with investor demand. This method allows for greater flexibility and potentially better reflects the market value of the shares.

Advantages of investing in an IPO

Investing in Initial Public Offerings (IPOs) presents investors with a range of potential advantages. Various benefits of investing in an IPO are explained as follows:

• Gains from Listing:

One of the primary benefits of investing in an IPO is the potential for listing gains. If a company debuts on the stock exchange at a price higher than the offer price, investors who applied for shares at the offer price can realize significant profits. This difference between the listing price and the offer price can lead to substantial short-term gains.

• Enhanced Liquidity:

Once a company goes public, its shares are traded on the open market, providing investors with the ability to buy and sell shares freely. This enhanced liquidity ensures that investors can convert their shares into cash at any time, offering flexibility and ease of access to their investments.

• Fair Opportunities for Retail Investors:

The Securities and Exchange Board of India (SEBI) has implemented regulations to ensure that small retail investors have fair opportunities in IPO share allocations. These relaxed norms include provisions that, in cases of oversubscription, aim to allocate at least one lot of shares to all retail investors, subject to availability. If individual lot allocation is not feasible, a lottery system is used to distribute shares equitably.

• Cost-effective Purchase:

When companies go public, they often offer shares at a discounted rate compared to their potential market value. This allows investors to acquire shares at a lower price, providing an opportunity for long-term wealth creation if the company performs well and its share price appreciates over time.

• Shareholder Authority:

Investing in an IPO and receiving share allotments confers shareholder status, granting investors voting rights in the company’s annual general meetings. This sense of ownership allows shareholders to have a say in the company’s decisions and strategic direction, providing a level of influence and engagement in the company’s future.

Eligibility Criteria for investing in an IPO

To be eligible for investing in an IPO, an individual must meet several key criteria:

1. The investor must be an adult capable of entering into a legal contract.
2. Possessing a PAN card issued by the Income Tax Department is mandatory.
3. A valid demat account is essential for holding the shares. While having a trading account is not necessary for applying to an IPO, it becomes required if the investor decides to sell the shares upon listing. These criteria ensure that investors are properly registered and have the necessary accounts to manage their investments in the public market.

Conclusion

An IPO can provide growth opportunities and benefits for both the company and investors. By understanding the IPO process wisely, investors can capitalize on these opportunities and potentially achieve significant returns on their investments.