What is IPO? Types, Benefits & How It Works

At the beginning, the very concept of IPO investments made me think of a sophisticated financial instrument that could be grasped only by the pros. However, I soon found out that the whole Initial Public Offering process is nothing but the very first time a private company sells its shares to the general public through stock brokers registered with stock exchanges.

What is IPO (Initial Public Offering)?

What does IPO mean in the stock market? It is the moment a firm changes its ownership from private to public. This procedure enables small investors such as you and me to own a part of the companies that we trust.

Grasping the mechanism of IPO investment was a turning point in my investment journey, and now I want to explain it in the easiest way possible.

IPO Full Form and Meaning

The abbreviation IPO represents Initial Public Offering. In other words, let me tell you the practical meaning behind it.

The IPO's full meaning in the stock market indicates the very first time a corporation offers its stock to the public via stock exchanges. The first round of investments to establish a company is made by the founders, early investors, and venture capitalists. After the IPO, the company shares can be purchased by anyone who has a Demat account.

Initially, the four of you are the only ones who own the company. When you decide to grow and you need more funds, you can sell shares to the public. That is basically your IPO.

Companies do this mainly to obtain money for growth, pay their debts, or let the early investors exit with their profits.

How Does an IPO Work?

The IPO runway consists of a whole sequence of steps that the issuers need to adhere to before their stocks become publicly tradable. Allow me to explain how it goes in practice.

To start with, the corporation engages in hiring investment banks, which function as underwriters. So basically, these banks are the ones to assess the company's worth, indicate the price of shares, and locate the purchasers. This collaboration is vital since underwriters are the ones who secure the IPO's triumph.

Here is the common timetable:

Step 1: The company submits its papers to SEBI (Securities and Exchange Board of India)

Step 2: The review process is conducted by SEBI, and the offering is approved

Step 3: The company issues a prospectus disclosing financial information

Step 4: Roadshows and investor marketing are launched to draw people in

Step 5: The price band is set according to the interest shown

Step 6: The subscription window is opened (normally for 3 days)

Step 7: The allocation is done as per the oversubscription

Step 8: The shares are introduced on the stock exchanges

The question of what ipo stock is has already been answered- IPO stocks are fresh shares that were never traded on the market before. After being listed, they are traded just like any other stock on either the BSE or NSE.

I have a strong feeling that the knowledge of the ipo process empowers the investors in making better selections of the IPOs that are worthy of their applications.

Types of IPO

The possible IPOs they can have are numerous, and they widely depend on their purposes and market conditions. Allow me to elaborate on the main types.

Fixed Price IPO

In this category, the company sets a certain stock price before the beginning of the subscription. The investors know the precise amount that they need to pay. There is no price discovery in this case; the displayed price is the price you pay. It used to be more common in the past, but now it is less often used.

Book Building IPO

Today, this is the predominant type in India. The firm gives a price range (price band), then investors submit their bids within that range. The price is finally set according to the demand. For instance, if the price band is ₹100-₹110, the final price might be ₹108 after the bidding process.

Book building provides flexibility and guarantees a market-based price. The method is mostly used for the largest IPOs in the Indian market, as it captures the actual demand of the market.

Being aware of the type you are applying for can make a difference, as it will influence your bidding strategy as well as the returns you expect.

Benefits of IPO Investment

IPO investment is a lucrative option for retail investors due to a number of reasons. Out of those, I will describe the main benefits that the investors usually see.

Opportunity of early entry: You have the chance to invest in companies at their listing price, which is likely to be the lowest price before their huge rise. Some IPOs get back the investor's money with a 50-100% return right on the day of listing itself.

Potential of wealth creation: It is a common practice for quality companies to grow considerably post IPO. The investors who got allocated shares during the IPO of Zomato or Nykaa also experienced their growth story from the very first day.

Diversification of portfolio: IPOs open up new sectors and the markets of brand new businesses. Your investment is not confined to companies that are already listed.

Entrance price lower: IPO prices are frequently established in a very attractive manner in order to draw in good subscriptions. The price you will pay when the stocks are first issued may be less than the price you will pay in the market after the stocks are first issued.

Company's reckoning: The companies are required to tell the truth and nothing but the truth through their prospectus about their financial situation. This openness can lead investors to make better decisions.

Those investors who want to be aware of the company's fundamentals before the application stage will find it valuable to understand basic concepts of financial analysis. Dhanarthi.com is one of the platforms that provides resources for a systematic evaluation of IPO companies.

Disadvantages and Risks of IPO Investment

While IPOs offer exciting opportunities, they also come with significant risks that every investor should understand before investing.

Limited historical data: Unlike established listed companies, IPOs lack a trading history. You can't see how the stock performs during market ups and downs, making technical analysis challenging.

Volatility on listing day: IPO stocks can experience wild price swings on their first trading day. Some stocks list at huge premiums while others list below their issue price, causing immediate losses.

Lock-in period risks: Promoters and early investors often have lock-in periods. When these shares get unlocked and flood the market, it can create selling pressure and push prices down.

Overvaluation concerns: Some companies price their IPOs too high to capitalize on market hype. The grey market premium doesn't always translate to listing gains, and overvalued IPOs often correct sharply post-listing.

Low allotment chances: Popular IPOs get oversubscribed 50-100 times, drastically reducing your chances of getting shares. You might block funds for 10 IPOs but get allotment in only one or two.

Regulatory and business risks: New public companies face intense scrutiny and must maintain quarterly disclosures. Management inexperience in handling public expectations can lead to operational challenges.

Being aware of these risks helps you make balanced decisions rather than getting caught up in IPO excitement.

How to Invest in an IPO in India

Buying an IPO in India has become less complex because of technology. Let's go through the necessary steps.

Requirements before applying:

• Active Demat account with a broker
• Linked bank account with sufficient funds
• PAN card for KYC verification
• UPI ID for payment blocking

Application Process:

1. Check Upcoming IPOs: Keep an eye on financial websites or your stockbroker's app for new offerings.

2. Read the Prospectus: Comprehend the firm, its financials, and risk factors before submitting your application. Review the company's annual report details thoroughly.

3. Decide Bid Amount: Select the number of shares and the price (for book building IPOs within the price band).

4. Apply through Platforms: The broker's app, net banking, or ASBA facility are your application channels.

5. Block Funds: Your account will have the amount blocked until the shares are allotted.

6. Wait for Allotment: The results are usually available 7-10 days after the closing of the subscription.

7. Shares Credited: If you got the allotment, shares would be in your Demat account before listing.

The whole procedure takes about 5-10 minutes, provided that you have already done your research about the company.

To evaluate whether a company going public has strong fundamentals, a stock screener like Dhanarthi can compare financial ratios against the industry averages, thus providing clearer insights for decision-making.

IPO Examples in India

Real-world examples help you understand how IPOs can perform differently based on company fundamentals and market conditions.

Successful IPO Examples:

Zomato (2021): Listed at ₹116, opened at ₹125 on listing day (8% gain). The stock saw massive volatility but rewarded long-term investors who believed in the food delivery sector's growth potential.

Nykaa (2021): One of the most successful recent IPOs, listing at a huge premium of over 80%. The beauty and fashion e-commerce platform's strong business model attracted massive investor interest.

LIC (2022): India's largest IPO by value at ₹21,000 crores. Though it listed below the issue price initially, it demonstrated how even established companies can face market headwinds.

Disappointing IPO Examples:

Paytm (2021): Listed at a discount to its issue price of ₹2,150 and continued falling for months. It highlighted the risks of high valuations and profitability concerns in the fintech space.

Adani Wilmar (2022): Despite being part of the Adani group, the stock struggled post-listing due to market conditions and valuation concerns.

These examples show that IPO success depends on multiple factors: company fundamentals, sector outlook, market sentiment, and valuation. Not every IPO guarantees profits, making thorough research essential.

For better IPO evaluation, investors should also understand key metrics like PE ratio, debt to equity ratio, and the company's balance sheet strength before applying.

Conclusion

Understanding what an IPO is and how the IPO process works empowers you to participate in potentially rewarding investment opportunities. IPO investment offers early access to growing companies, but comes with risks like volatility and overvaluation.

The key to successful IPO investing lies in thorough research, understanding the IPO in full in the share market, and not getting carried away by market hype.

Apply only to companies with strong fundamentals, reasonable valuations, and clear growth paths. Learn how to increase IPO allotment chances through strategic bidding and application methods.

Diversify your portfolio, never invest more than you can afford to lose, and remember that not every initial public offering guarantees profits. For comprehensive investment guidance, check out stock market trading tips for beginners to develop a well-rounded approach. Make informed decisions based on facts, not emotions.

Disclaimer: This article is for educational purposes only and should not be considered as financial or tax advice. Tax laws are subject to change, and individual circumstances vary. Please consult with a qualified chartered accountant or tax advisor for personalized guidance based on your specific situation.

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