All About Initial Public Offering (IPO) in India

The stock market has become one of the most thrilling places for investors in India, particularly with the growing number of Initial Public Offerings (IPOs). A number of companies every year venture into the market by offering their shares to the masses for the first time. Investors will tend to view IPOs as a way to make listing gains or to invest at an early stage in successful companies. It is, however, of utmost importance to understand precisely what an IPO is, how it functions, and what factors to consider before investing. This blog is a simple, organised way to learn everything about IPOs.

What is an IPO?

An Initial Public Offering (IPO) involves a privately owned company issuing shares to the general public for the first time. Once the IPO is successful, the company gets listed publicly, and its shares are traded on the stock exchange. Basically, an IPO helps corporations raise financing from investors to expand their business or operations, relieve debt, or finance new projects.

When an organisation is brought into the market, it is no longer under the ownership of a limited number of people (promoters, founders, early investors) but a broader base of shareholders comprising retail investors, institutional investors and foreign investors.

What are the Reasons Why Companies Issue an IPO?

The issuance of an IPO by companies is based on various strategic and financial considerations. Raising capital is one of the most important reasons. The use of public funds enables companies to grow faster, invest in technology, acquire assets, venture into new markets, or enhance their infrastructure.

Brand visibility is another reason. Listing on a stock exchange creates trust and increases credibility. Vendors, investors and customers begin to think that the company is more stable and transparent.

An IPO also provides an exit for early investors and promoters. They are able to part with part of their interest at a high value, which could not have been the case previously when the firm was being floated.

Types of IPO Issues

During an IPO, two different types of offerings are typically issued:

1. Fresh Issue

The new issue implies that the company is issuing new shares to generate capital. The funds collected are channelled back to the firm and can be utilised for business growth, debt repayment, or running expenses.

2. Offer for Sale (OFS)

In an OFS, shareholders or existing promoters sell their shares to the public. There is no addition of new money in the company, so that ownership is only transferred by the existing investors to new investors in the company.

A number of IPOs have a fresh issue + OFS.

How Does the IPO Process Work?

Learning about the IPO process will give investors insight into what happens behind the scenes before the listing.

• Hiring of Investment Bankers: Merchant bankers are companies appointed by companies to prepare the IPO structure, valuation, pricing, and documentation.
• Draft Red Herring Prospectus (DRHP): The DRHP companies submit to SEBI have valuable information such as financial statements, business model, risks, promoter information and IPO objectives. SEBI goes through the document and proposes modifications where necessary.
• Price Band and Lot Size: The companies determine the price band (lowest and highest price per share), and lot size (minimum quantity of shares that a retail investor has to apply).
• Bidding and Subscription: In the IPO window, a share application is made by investors. In case the requirement is high, the IPO gets oversubscribed. Bidding occurs via an ASBA system to an online system in which the funds are not released until allotted.
• Allotment of Shares: Once the subscription period is over, the shares are apportioned accordingly on a demand basis. Retail investors are allotted by means of a lottery system in case of oversubscription.
• Listing on the Stock Exchange: After allotment, shares are listed on the stock exchange. Depending on the market demand, the listing price can be overpriced or underpriced relative to the IPO price.

Who Can Invest in an IPO?

There are various kinds of investors in IPOs:

1. Retail Investors: Those who invest less than Rs. 2 lakh fall in this bracket. They are provided with a quota of reserved slots, and can apply either via UPI or net banking.
2. High-Net-Worth Individuals (HNI/NII): Investments more than Rs. 2 lakh are under this category. The amount applied is allotted proportionally.

These are banks, mutual funds, foreign institutional investors and insurance companies.

The Advantages of Investing in an IPO

• Early Entry Opportunity: The investors are able to purchase the shares at the initial price when the company has not yet established itself well in the market.
• Potential Listing Gains: There are IPOs where the initial price is lower than the listing price, providing the investors with an immediate profit.
• Long-Term Wealth Creation: Great firms like Infosys, TCS, Avenue Supermarts (DMart), and IRCTC have generated immense long-term wealth for the investors of IPOs.
• Transparency: SEBI regulations provide that companies should share all financial and operational information prior to an IPO launch, and therefore enable investors to make knowledgeable decisions.

Risks During the IPO Investment

• Market Volatility: Listing price may be lower than the issue price when the market in general is poor.
• Overhyped Valuations: Other firms hold IPO at extremely high valuations that are risky upon being listed.
• No Guarantee of Allotment: Oversubscribed IPOs do not necessarily allocate shares to everyone who makes an application.
• Business Risks: The appearance of new companies is not necessarily going to work as expected, and this can affect the price of stock.

How to Evaluate an IPO before Investment?

Prior to the application of an IPO, consider:

• Financial performance of the company.
• Profitability and growth potential.
• Background and credibility of the promoter.
• Business model and competitive advantage.
• Comparison of valuation with industry peers.
• Use of IPO funds
• Market sentiment

A well-studied IPO can deliver long-term returns, while an overpriced IPO can lead to losses.

Conclusion

An IPO is among the most favoured methods for businesses to raise capital and for investors to participate in early-stage growth. Nonetheless, IPO investment must never be done on hype but on research and insight. Although IPOs provide a chance to attain short-term and long-term wealth, they have their risks. Utilising a balanced approach, i.e. getting to know the business, its valuation, the market climate and the demand for subscriptions, can enable the investors to make smart decisions and create a more solid portfolio.