IPO Basics: Understanding Initial Public Offerings

What is an IPO?

An Initial Public Offering (IPO) is the process through which a privately held company becomes publicly traded by offering its shares to the general public for the first time. This transition marks a significant milestone in a company's growth journey, allowing it to raise capital from public investors.

During an IPO, a company issues new shares, existing shareholders might sell some of their holdings, or both. These shares are then listed on stock exchanges like the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE), where they can be bought and sold by retail investors, institutional investors, and other market participants.

Why Do Companies Go Public?

Companies choose to go public for several strategic reasons:

• Capital Raising: The primary reason for most IPOs is to raise substantial capital for business expansion, debt reduction, research and development, or acquisitions.
• Liquidity for Existing Shareholders: IPOs provide an exit opportunity for early investors like venture capitalists and angel investors, allowing them to realize returns on their investments.
• Enhanced Public Profile: Being a publicly traded company increases visibility, credibility, and brand recognition, which can benefit business relationships and customer acquisition.
• Currency for Acquisitions: Public companies can use their stock as currency for acquiring other businesses, often more easily than private companies.
• Employee Recruitment and Retention: Public companies can offer stock options and equity incentives, which can help attract and retain top talent.

The IPO Process in India

The journey from being a private company to listing on a stock exchange involves several stages:

1. Preparation Phase

Before initiating an IPO, a company must ensure it meets the eligibility criteria set by SEBI and stock exchanges. This typically includes having:

• A minimum net tangible assets of ₹3 crore
• A minimum average operating profit of ₹15 crore during the preceding three years
• A net worth of at least ₹1 crore in each of the preceding three years
• If the company doesn't meet the profit criteria, it needs at least 75% of the issue size allocated to Qualified Institutional Buyers (QIBs)

2. Hiring Investment Bankers

The company appoints investment banks as Book Running Lead Managers (BRLMs) who guide the company through the entire IPO process, help determine the issue price, and market the offering to potential investors.

3. Filing Draft Red Herring Prospectus (DRHP)

The DRHP is a comprehensive document submitted to SEBI containing detailed information about:

• The company's business operations and financial performance
• Risk factors associated with the business
• Management structure and promoter background
• Objects of the issue (how the raised capital will be utilized)
• Legal proceedings and other material information

4. SEBI Review and Approval

SEBI examines the DRHP and may require clarifications or changes. Once SEBI provides its observations, the company can proceed with the IPO. This process typically takes 30-70 days.

5. Marketing the IPO

The company and its BRLMs conduct roadshows and presentations to institutional investors to generate interest in the offering. This includes:

• Investor meetings in major financial centers
• Presentations highlighting the company's business model, growth strategy, and investment thesis
• Media engagement to create awareness about the upcoming IPO

6. Price Band Determination

Based on investor feedback during roadshows and market conditions, the company and BRLMs set a price band for the shares being offered. The price band indicates the minimum and maximum share price at which investors can bid.

7. Opening for Subscription

The IPO typically remains open for subscription for 3-5 working days. Investors can place bids within the specified price band.

8. Allotment Process

After the subscription period ends, shares are allotted to successful applicants based on the demand and specified criteria for different investor categories (retail, QIBs, NIIs).

9. Listing and Trading

The shares are listed on the stock exchanges and begin trading, usually within 6 working days after the IPO closing date.

Investor Categories in IPOs

IPO shares are allocated across different investor categories:

Benefits and Risks of Investing in IPOs

How to Evaluate an IPO

Before investing in an IPO, thorough research is essential. Here are key factors to consider:

Common IPO Terms You Should Know

Red Herring Prospectus (RHP)

A preliminary document submitted to SEBI that contains all details about the company and the IPO except the price and number of shares being offered.

Book Building

The process where investors bid for shares within a specified price band, helping determine the final issue price based on demand.

Price Band

The range between the floor price and the cap price within which investors can bid for shares in an IPO.

Cut-Off Price

The final issue price determined after the book building process, based on investor demand.

Lot Size

The minimum number of shares an investor must apply for in an IPO. For retail investors, the minimum application amount is typically around ₹15,000.

Application Supported by Blocked Amount (ASBA)

A mechanism where the application money remains in the investor's bank account but is blocked until share allotment. If shares are allotted, the amount is debited; otherwise, the block is released.

Unified Payments Interface (UPI)

A payment system that allows retail investors to block funds for IPO applications through mobile apps like BHIM, Google Pay, or PhonePe.

Listing Gains

The profit an investor makes if the shares list at a price higher than the issue price.

Conclusion

Initial Public Offerings represent a significant opportunity for investors to participate in a company's growth journey from an early stage. However, like any investment, they come with risks that must be carefully evaluated.

By understanding the IPO process, conducting thorough research, and approaching each offering with a balanced perspective, investors can make informed decisions about whether a particular IPO aligns with their investment goals and risk tolerance.

Remember that while some IPOs deliver outstanding returns, others may underperform. Diversification, patience, and a focus on fundamentals rather than market hype are key principles for successful IPO investing.