All you need to know about IPO - Definition, Process and Investment Tips

Welcome to the world of IPOs – a place where companies go from privately held to publicly traded, and investors like you have the chance to invest in early-stage companies and benefit from their success. In this article, we will explore the basics of IPOs, so you can understand what they are, how they work, and how to invest in them. 

If you already know about IPOs, track the Upcoming IPOs of 2024 in Ticker for free. 

What is an IPO?

An Initial Public Offering (IPO) is a significant milestone for companies that transforms them from privately held entities to publicly traded enterprises. It is the process by which a company offers its shares to the public for the first time, allowing individuals and institutions to invest in its growth and success.

Through an IPO, companies can raise capital to fuel expansion, enhance visibility and credibility, and provide an exit opportunity for early investors. This momentous event not only opens doors for businesses but also offers individuals the chance to participate in the early stages of promising ventures and potentially reap the rewards of their future achievements.

History of IPOs

The concept of IPO traces back to 1602 when the Dutch East India Company offered its shares to the public. During the 19th century, companies in the US started raising public funds to finance the construction of railroads. In India, after the liberalisation in 1990, companies started using IPOs to collect funds by inviting people to buy shares in their businesses. In recent times, the Indian government has implemented various initiatives to promote IPOs and encourage public participation in the capital market.

Dutch East India Company (1602):
The first recognizable IPO in history is often attributed to the Dutch East India Company. In 1602, the company offered shares to the public, providing investors with tradable securities. This marked a crucial moment in the development of the modern financial market.

19th Century:
During the 19th century, especially in the United States, companies started to raise public funds to finance the construction of railroads, and investors saw this as an opportunity for significant returns.

Post-Independence Era:
After gaining independence in 1947, India focused on economic development, but most of the entities were funded through government investments, and public involvement in the capital market was limited.
But after the Liberalisation(1990) the government opened up the economy, encouraging private sector participation and foreign investments. During this time, companies in India started using IPOs more to get money. It was like a comeback for IPOs – a way for companies to collect funds by inviting people to buy shares in their businesses.

Recent Developments:
India experienced a surge in entrepreneurial activity, particularly in the technology and e-commerce sectors. This led to the rise of Indian unicorns—startups valued at over a billion dollars. The Indian government has implemented various initiatives to promote IPOs and encourage public participation in the capital market.

Why do Companies go public?

Companies file for an IPO mainly to meet their CAPEX requirements. It also allows them to raise capital, provides liquidity for existing shareholders, offers employee stock options, enhances visibility and credibility, and creates opportunities for partnerships and debt financing.

1. Raise Capital - Going public allows a company to raise significant capital by selling shares to a wide range of investors. This money can be used for various purposes, such as funding expansion, research and development, paying off debt, or making strategic acquisitions.
    

2. Liquidity for Existing Shareholders - Going public provides an opportunity for existing shareholders, including founders, early investors, and employees, to sell their shares and realise gains. This liquidity is often seen as a benefit for those who have invested time and money in the company.
    

3. Employee Stock Options - Being publicly traded can make it easier for a company to attract and retain talented employees by offering stock options or equity as part of their compensation packages. The shares are provided at a discount to the employees and when the company goes public, the employees will see capital appreciation.
    

4. Enhanced Visibility and Credibility - Going public increases a company's visibility and credibility in the marketplace. It can attract attention from customers, suppliers, and partners, potentially leading to new business opportunities and partnerships.
    

5. Access to Debt Financing - A publicly traded company may find it easier to access debt financing at favourable terms because it has a transparent financial history and a valuation that can be easily determined through its stock price.
    

6. Competitive Positioning - Being listed on a stock exchange can enhance a company's competitive position. It can be seen as a marker of success and stability, potentially attracting more customers and partners.

 If you want to know more about why companies go public, you can read it in detail on one of our blogs on Insider by Finology. 

Advantages of IPO for an Investor

Investing in Initial Public Offerings (IPOs) presents a range of advantages for investors keen on exploring new opportunities in the stock market. From profit potential and access to promising companies to enhanced liquidity and portfolio diversification, IPOs offer a gateway to tap into the growth stories of emerging ventures.

1. Profit Potential: IPOs offer the potential for substantial returns on investment. Early investors may benefit from the company's growth trajectory and enjoy significant share price appreciation if the company performs well.
    

2. Access to New and Promising Companies: IPOs provide investors with the opportunity to invest in exciting, innovative, and potentially disruptive companies that are entering the public market for the first time. This allows investors to be part of a company's growth story from an early stage.
    

3. Portfolio Diversification: Investing in IPOs can add diversity to an investment portfolio. By allocating funds into IPOs across different sectors and industries, investors can spread their risk and potentially tap into emerging trends and industries.
    

4. Enhanced Liquidity: Once a company goes public, its shares become tradable on the stock exchange, providing investors with increased liquidity. They have the option to buy or sell their shares on the open market as per their investment goals and market conditions.
    

5. Participation in Initial Buying Opportunities: IPOs give investors the chance to buy shares of a company at the initial offering price, which can be lower than the price at which the shares start trading in the secondary market. This potential for early entry may allow investors to secure more favourable purchase prices.

Disadvantages of IPO for an Investor

While Initial Public Offerings (IPOs) present enticing prospects, they also come with several disadvantages that investors need to weigh carefully. From the lack of historical data and potential volatility to the risk of overvaluation and lock-up periods, investors must navigate uncertainty and exercise caution when considering IPO investments.

1. Lack of Historical Data: Since IPOs involve newly public companies, there may be limited publicly available information and financial data for investors to evaluate. This lack of history makes it challenging to assess the company's performance and future prospects accurately.
    

2. Volatility and Uncertainty: IPOs can be highly volatile, with share prices often subject to significant fluctuations immediately after listing. Investor sentiment, market conditions, and the company's performance can all contribute to this volatility, which may lead to potential losses or unexpected outcomes.

3. Risk of Overvaluation: There is a risk that IPO stocks may become overvalued due to hype and investor enthusiasm. Investors must carefully assess the company's valuation and growth prospects to avoid paying an inflated price for the shares.
    

4. Lock-up Periods: Many IPOs have lock-up periods during which certain shareholders, including company insiders, cannot sell their shares. This restriction can lead to additional price volatility once the lock-up period expires, as shareholders may rush to sell, potentially driving the stock price down.
    

5. Market Risk and Market Timing: IPOs are influenced by broader market conditions and investor sentiment. If the overall market experiences a downturn or if there is a lack of demand for IPOs, investors may face challenges in realizing gains or even suffer losses.
    

It's essential for investors to carefully assess the advantages and disadvantages of investing in IPOs, taking into account their risk tolerance, investment objectives, and the specific characteristics of each IPO opportunity. Conducting thorough research and seeking professional advice can help investors make informed decisions.

Types of Investors in IPO

Investing in Initial Public Offerings (IPOs) provides opportunities for various types of investors, each with their own investment limits, bidding options, and allocation quotas. Retail investors, Non-Institutional Investors (NIIs), Qualified Institutional Buyers (QIBs), and Anchor Investors all play a crucial role in the IPO market.

While retail investors enjoy a higher investment limit and flexible bidding options, NIIs and QIBs provide larger investments and have specific quotas for different IPO types. Anchor investors, on the other hand, invest before the IPO and have specific lock-in periods for selling shares. Understanding the different types of investors can help navigate the IPO landscape effectively.

1. Retail Investors: Retail investors have a maximum investment limit of Rs. 2 lakhs in an IPO. They can bid at the cut-off price, withdraw bids, and have different quota percentages depending on the IPO type. There is no lock-in period for retail investors, allowing them to sell shares anytime after listing.
    

2. Non-Institutional Investors (NIIs): NIIs can be further categorized as Small NII (bidding for ₹2-10 lakhs) and Big NII (bidding above ₹10 lakhs). They have specific quota percentages depending on the IPO type, and their allotment process is based on the lottery method. NIIs also have no lock-in period, enabling immediate selling of shares after listing.
    

3. Qualified Institutional Buyers (QIBs): QIBs include mutual funds, commercial banks, public financial institutions, and foreign portfolio investors. They have no investment limit and specific quota percentages depending on the IPO type. Once the bids are made, they cannot be withdrawn. There is no lock-in period for QIBs, allowing free trading of shares after listing.
    

4. Anchor Investors: Anchor investors invest in a company before it goes public. They must invest a minimum of ₹10 crore in regular IPOs and Rs 1 crore in smaller IPOs (SMEs). Anchor investors have specific lock-in periods, with 50% of the shares being sellable after 30 days and the remaining after 90 days.

Understanding the various types of investors in IPOs helps investors evaluate their own investment strategies and align them with the opportunities and limitations presented by each investor category.

How to Apply in an IPO: Online Application Procedure through a Broker

To apply for an IPO, there are certain requirements you need to fulfill, including having a bank account, demat account, trading account, UPI ID, and PAN card. Once you have these essentials in place, you can apply for an IPO through both online and offline methods.

If you prefer the convenience of applying online, here is a step-by-step procedure to apply for an IPO through a broker:

1. Log in to your online account with your broker: Access your broker's website or trading platform and log in using your credentials.
    

2. Visit the IPO section: Navigate to the IPO section on the broker's platform. This section typically provides information about ongoing and upcoming IPOs.
    

3. Select the IPO in which you want to apply: Choose the specific IPO you wish to apply for from the available options. Read and understand the details and disclosures provided for that IPO.
    

4. Write the number of lots you want to apply for: Lots represent the number of shares you aim to purchase in the IPO. Specify the number of lots you want to apply for based on your investment preference.
    

5. View the total price on the screen: Once you have entered the number of lots, the platform will display the total price that you will be required to pay for the allocated shares.
    

6. Enter your UPI ID and confirm it: Provide your UPI ID, which is linked to your bank account and used for making payments and receiving share allotments. Ensure that the UPI ID you enter is accurate.
    

7. Accept the UPI mandate from your UPI app: After confirming your UPI ID, you will receive a notification or mandate on your UPI app. Open the app and accept the UPI mandate to authorize the payment for the IPO application.

It's important to note that the actual application process may vary slightly depending on the broker's platform. Always follow the specific instructions provided by your chosen broker.

If you are unsure about which broker to select for your IPO applications, you can visit the Select by Finology. It provides a comprehensive comparison of brokers based on your specific needs and requirements. 

How to make a decision to apply in an IPO?

Investing in an Initial Public Offering (IPO) requires careful analysis and consideration. To make an informed decision about whether to apply for an IPO, there are several key factors to keep in mind. These include assessing the Grey Market Premium (GMP), evaluating the IPO subscription status, and reviewing the company's Red Herring Prospectus (DRHP).

• Analyzing the Grey Market Premium (GMP)

The Grey Market Premium (GMP) is the difference between the unofficial market price of an IPO share and its official IPO price. A higher GMP suggests a potential for significant returns on the listing day, while a lower GMP may indicate limited upside. Monitoring the GMP can give you an idea of market sentiment and help you gauge potential returns.

• Evaluating the IPO Subscription Status

Checking the subscription status of an IPO is crucial to understanding market demand. If an IPO is oversubscribed by a large number of times, it indicates strong investor interest. In such cases, there may be better chances of significant returns. Conversely, if the IPO is not fully subscribed, it may result in a limited premium or even a discounted listing price.

• Reviewing the Red Herring Prospectus (DRHP)

When a company brings its IPO, it is mandatory for them to issue a Red Herring Prospectus (RHP). This document contains critical information about the company, including its financials, competitors, industry or sector analysis, management team, associated risks, future prospects, and vision. Analyzing the DRHP can give you valuable insights into the company's potential for growth and its position within the market.

• Accessing Detailed IPO Analysis

To obtain detailed analysis and information on ongoing and upcoming IPOs, including the DRHP and RHP, you can visit IPO section on Ticker. Ticker provides comprehensive research and insights into various IPOs, helping you make informed investment decisions.

Important Considerations for IPO Evaluation

When assessing an IPO, it's essential to consider the following information:

1. Financials of the company: Analyze the company's financial statements, including revenue, profit margins, and any existing debts. Evaluate its growth trajectory and financial stability.
    

2. Competitors of the company: Identify the competitive landscape in which the company operates. Assess the company's market position and potential for differentiation from competitors.
    

3. Industry or Sector of the company: Understand the dynamics and growth prospects of the industry or sector in which the company operates. Evaluate factors such as market size, trends, and regulatory environment.
    

4. Management of the company: Assess the experience, track record, and expertise of the company's management team. Strong leadership can be an indication of effective execution and future growth potential.
    

5. Risk associated with it: Identify and evaluate the risks specific to the company, such as market volatility, regulatory changes, and competitive pressures. Understanding and mitigating these risks is crucial for making an informed investment decision.
    

6. Future aspects of the company: Consider the company's growth potential, expansion plans, and upcoming product launches. Evaluate whether the company is well-positioned for future success.
    

7. Vision of the company: Understand the company's long-term vision, strategic goals, and alignment with changing market trends. Evaluating the company's vision can help determine its sustainability and potential for value creation.

By considering these factors and conducting thorough research, you can make a well-informed decision when applying for an IPO.

In conclusion, IPOs provide companies with an opportunity to raise capital, enhance visibility, and offer exit opportunities for early investors. With the Indian government's initiatives to promote IPOs and encourage public participation in the capital market, we can expect to see more companies going public and more investors taking advantage of these opportunities.

If you're interested in investing in IPOs, it's important to do your research and understand the risks and potential rewards involved.