IPO or Initial Public Offering – Concept, Types, Terms, Investment Process, Benefits & moreLast Updated Date: Nov 17, 2022
Initial Public Offering or IPO, sounds interesting! Of course, it is.
Unlike other companies with a pre-existing position in the industry, IPO provides the opportunity for the new and fastest-growing companies to make an appearance in the stock market.
These days, investors rush to find the best IPO options roaming around the financial market, as its benefits are enormous.
Even companies yearn to get their name in the top IPO list as it yields profitability in the company’s account as well.
But what is Initial Public Offering or IPO? How does it work? What are its pros, and who should avoid it?
If you are also on the hunt for the answers to such questions, you have undoubtedly got the right place.
Below we have brought together all information about the IPO so that you could find your interest in this exciting investment opportunity.
What is an IPO (Initial Public Offering)?
IPO or Initial Public Offering is the process by which an existing company issues shares, sells stocks or give a significant part of their ownership to the stockholders.
To simply put, when a privately-owned company becomes a publicly-traded company for the first time, the process is referred to as IPO (Initial Public Offering).
The term “Initial Public offering” can also be used as “Going Public” as the company owner decides to allocate its shares with the general public.
When a company aspires to raise more money to infuse ample equity capital in the firm, they may go with an Initial Public Offering.
For instance, Initial Public Offerings enable the retail traders in the open market to invest in a company’s shares.
In this way, the company does never get short of funds and continues to grow, whereas investors who purchase these shares anticipate profits.
The transition from a privately-owned company to a publicly-owned company can be an important phase for all investors. But for the company itself, this phase isn’t less than a big turning-point.
A private corporation, through IPO, becomes a public company. Similarly, it may have to face off with few advantages or disadvantages –
Advantages of Going Public
- A massive capital boost leads to the expansion of a company
- Capacity increases to purchase or combine with other companies.
- Original private investors observe a massive surge in the value of their investment.
- The opportunity to recruit skilled management in a competitive manner
Disadvantages of Going Public
- The cost of the process is incredibly high.
- Original stockholders may not be able to trade their shares right away because doing so might lower the stock price.
- The Board of Directors has authority over the company. The original corporate owners might not have been part of this party.
- The SEBI is now constantly monitoring the company.
So this how you can understand the pros and cons of entering the IPO to a company that also provides special insight to the investors on how well the company is likely to work in the stock market.
If you anticipate that your investment yields more results for you, noticing these few critical points is always worth it. Moreover, IPO can be of two types about which we’ll discuss next.
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Types of IPO
Here are the two most common types of Initial Public Offering that you must know –
Fixed Price Offering
The issue price at which the company makes initial sales of its shares refers to as a fixed price IPO.
In other words, it is the first phase when the price of the Stocks or Shares that a company wishes to make public is revealed to the investors.
Once the issued price comes to light, the traders demand, and interest for the stocks can be determined in the open market.
Book Building Offering
In the event of book building offering, the enterprise initiating an Initial Public Offering may provide investors with a significant price band on the stocks (normally 20%).
Until the final price is set, prospective traders make bids for the shares.
Meanwhile, traders must determine the number of shares they plan to purchase as well as the price per share they are ready to invest.
The floor price of a stock is the lowest price point, while the cap price is the highest. Normally, investors’ bids decide the final price of the shares.
How to Invest In an IPO? Step By Step Process
There are certain rules and steps that one needs to follow to commence the best investment plan on IPOs.
Lack of required knowledge and skills are less likely to deliver you any result. You may find yourself in a significant financial tribulation if you aren’t working upon the principles of investment.
Here are some simple yet valuable steps to invest in an IPO that helps you get more out of your expectations from the new stocks.
Step 1 – Do Essential Homework on IPOs
Don’t proceed until you are fully confident about your decision. The initial step can later turn out to be more harmful if you aren’t active right from the beginning.
Investment in IPO demands lots of research work like other stocks in the open market. You can’t conclude the performance of a company through its rising prices in the stock market.
Since these companies have recently stepped into the open market, your technical analysis may not work for it.
The real-life study of the company may provide a thorough insight into its futuristic performance.
Gather more knowledge about the company. Check if it is working on a profitable niche or industry if they are using advanced techniques or solutions.
Note down the company’s growth in the sector in comparison to its rivals. The obtained results help you make the best decision.
Step 2 – Invest strategically
After addressing the best IPO, arrange the funds required for investment. Don’t put your life-time savings in one go; divide the amount across different investments.
But make sure you are already aware of the fact that, unlike other shares, you can’t pick a single or individual share in an IPO. Instead, you may have to buy a series of shares on a single transaction.
You are allowed to invest in multiple Initial Public Offerings, but only if you have a big amount for investment as the shares are available in bulk rather than a single one.
Investors can even take loans from banks or financial institutions to get sufficient fund for investment.
But make sure that your confidence over that IPO alternative should be more than your debt.
Step 3 – Opening a Demat & Trading Account
Once you are all set with your preference of IPO and required fund, it’s time to take action and find the best trading platform.
Opening a demat account is mandatory to start investing in IPO. Using the demat account, you can trade securities online.
For the account opening, you may require identity proof to show, e.g., adhaar card, pan card, home address and other essential documents.
However, opening a demat account isn’t that tricky. It can be done online with a few simple steps. But make sure that you are trusting on a reliable platform only.
Wander around in search of the best stockbroker. Review all the best options one by one. Once you find the best broker, start your journey with a few simple steps.
Step 4 – The Application Process
Now let’s talk about the application process for investment in IPO. Once you successfully create your demat-cum-trading account, you can begin investing in Initial Public Offerings.
But the next most requisite step is to understand Application Supported by Blocked Account (ASBA).
The ASBA is mandatory for every applicant willing to invest in IPOs. ASBA is an application regulated by SEBI that enables banks to draw the funds directly from the applicant’s bank account.
SEBI verifies that the transactions are safe, and the trader could invest without any problem.
The cheque and demand drafts facility isn’t available. Apart from that, all facilities are accessible in the ASBA application.
Step 5 – Bidding
Now it’s time to select the price for bidding from the price range suggested by the company.
The lowest price will be the floor price, and the highest price will be the cap price. Select the bidding amount and type of share where you want to park your money.
Investors can even take a quick glimpse of their bidding anytime. But make sure you lock the required funds in due course.
Until the allotment is initiated, the arrest amount in your bank account continues to earn a significant interest amount.
Step 6 – Allotment of Shares
The demand for shares will always outnumber the original number of stocks available on the secondary market.
One could even find himself in a situation where he receives fewer shares than he had requested. In such instances, the banks either entirely or partially unlock these arrested funds.
However, if an investor is fortunate enough to receive a complete allotment, he may receive a Confirmatory Allotment Note (CAN) in less than six working days, right after the IPO’s completion. The shares are allocated to the investors.
After successfully completing the steps outlined above, wait for the stocks to be listed on the stock exchange. The whole process usually takes seven days to finalize the shares.
How does a Company offer IPO?
An investment bank is hired by the private company going public to handle the IPO. After this, the investment bank finalizes all the financial details with the company via an agreement.
The final step after the agreement is finalized is that the company along with the investment bank files the registration statement with the SEC.
After the SEC scrutinizes all the necessary documents, it allows a date for the announcement of the Initial Public Offering.
Once the Initial Public Offering is announced & circulated to the public, the general public then can apply for investment either online or via a form.
Once IPO allotment is done, it comes in the demat account of the investor.
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Tips for Investing in an IPO
Let’s take a closer look at certain pointers to keep in mind before trading in an initial public offering.
- Before investing, extensive analysis is needed. Look up the company’s current and previous results on the internet. Discover the future of the industry as a whole. This is a critical step in making an informed choice.
- Always stay updated on the company’s promoters. The chances of successful results are substantial if the people involved in the business are sound.
- Investing in companies affiliated with good underwriters and stockbrokers is a smart option, so choose the best broker as soon as possible.
- Companies, as previously mentioned, hold a number of information about themselves in their prospectus. Read it once before making a call.
- In the end, gather knowledge about IPOs, don’t leave even a piece of single helpful advice on IPO investing. With a bit of study, analysis, time, and persistence, you will undoubtedly become a leading investor.
Is it Good to Invest in an IPO?
IPO investment can prove to be a good choice for investment. Still, this question continues to evolve into a debatable subject.
Mainly among beginners who are curious to know everything about IPO, in particular about its profitability. So let’s hit a thorough discussion over it to draw the best answer.
IPO is more like an opportunity rather than just an alternative for investment. After all, these are the latest companies with innovative ideas.
Few of these companies may have a massive potential of becoming the leader of the future. It’s no surprise that such positive signals about IPO indicate some golden opportunities for investors.
For instance, look at today’s leading companies’ per-share price and compare them with prices ten years back. You may get to see a mind-boggling difference.
Their prices are still soaring because of the rising demands of the company and its shares. That makes a good reason why you must hunt for the best IPO alternatives.
Whenever you get news making headlines that a privately-owned company is likely to issue its shares in the open market, begin your research work on it.
Check out the company’s profile and its working performance over the last few years or months.
Still, you shouldn’t expect a happy ending for always as a couple of reasons equally illustrate the drawbacks of investment in Initial Public Offerings.
Drawbacks of Investing in IPOs
The first rule of thumb, “risk and rewards go hands in hands”, is the leading reason behind why you should stay away from IPOs.
In most instances, it is more likely to be possible that the business you anticipate would flourish successfully without any drop ends up biting a big chunk of your hard-earned money.
Sound research is always essential to make a wise investment decision. Else, IPO may also bring you into a significant loss.
Possible that the company you are investing upon is just a startup and struggling to make a good position in the industry.
It’s no surprise that, unexpectedly, you may put your money at risk. So make sure you hit a thorough research work on such companies and invest accordingly.
How Does IPO Work?
How the IPO works is that a private company usually offers its shares and stocks to the general public for the first time.
Through the public, the company would gain initial capital and then would be listed in the stock exchange.
To complete the whole process of the private company becoming a public company, there are other factors involved like a team of experts would be required to assess the whole procedure. By a team of experts, we mean auditors, lawyers, underwriters, etc.
Thus, from the above discussion, the concept of IPO becomes much clearer as to what an Initial public offering is and also the way in which they work.
Before releasing an IPO, a private company should be sure that they want to go public.
Critical Terms Used in an IPO Issue
Here are the List of Important Terms used in IPO Investment. It is important to know these terms before investing in an IPO.
Draft Offer Document / Draft Prospectus
Draft Offer Document/Draft Prospectus is a document comprising of some essential details about the company’s financial profile.
In a nutshell, this document defines the reasons for which the company is going public.
The document may even feature the pricing schedules, the background of the company, and its promoters.
SEBI and ROC verify the authenticity of these documents; thereby, the company can enter the stock exchange.
An underwriter refers to a financial institution, investment banker or broker that enters into a contract with the company initiating IPO.
The primary role of the underwriter is to subscribe to the remaining shares of the company, which the general public hasn’t picked up.
For example- if the company issues Rs.60 crores shares to the general public but receive a subscription for only Rs.50 crores, the underwriters may pick the remaining Rs.5 crores shares.
Red Herring Prospectus
Red Herring Prospectus also refers to as RHP. It is used in book building issues.
Except for price details, the number of shares issued over time, RHP may provide you with a thorough insight into the company’s profile.
Lead managers play a pivotal role in the due diligence of the issuing process. To simply put, lead managers are investment bankers or merchant bankers who act as-.
- Mediator between the investors and issuer (company initiate IPO)
- A person who is solely responsible for complying with the rules and regulation of IPO. For instance, marketing the issue or format of the prospectus.
- The lead manager is also responsible for further activities in the IPO process, e.g., refunds and allotments. Investors should contact the lead manager on the arrival of issues related to the shares or funds.
Green Shoe Options
Green Shoe Options also refers to an “over-allotment option” in legal terms, contributing a critical role in the IPO process.
Using the greenshoe options, the insurer ensures that the share price doesn’t drop below the issue price.
In a nutshell, it stabilizes the share prices that are listed on the stock exchange. However, the stabilization period lasts for 30 days only.
Qualified Institutional Buyers (QIBs)
QIB is deemed as an expert in financial matters who assess different parameters in the capital market for investment.
Anchor Investors are professional buyers who invest in the Company issue before it opens to the general public.
Though, anchor investors existence in the company’s shares also draws other investors’ attention. It helps the company in building public trust before the shares go public.
Applications Supported by Blocked Amount or ASBA
ASBA is an application that is originally developed by SEBI (India’s Stockmarket Regulator). The Application is predominantly used for subscribing to Initial Public Offering.
This facility ensures a smooth transaction between the bank and trading account. For instance, no amount is deducted from your bank account until the shares are allotted to the investor.
You just need to submit the ASBA form that asks you to give some essential details related to your banks, and your account will be ready to take action.
Visit the NSE website to download the ASBA form.
IPO or Initial Public Offering – Conclusion
There’s no wonder that IPO can be a golden opportunity for traders. IPO can be more profitable in comparison to existing companies in the stock market as new startups make it obvious.
One can generate enormous returns from IPO if the investment decision is well-informed and not based on technical analysis.
Already people are generating massive gains from IPO. But if you are just a beginner in the trading world, don’t proceed until you are fully familiar with the company’s profile initiating an Initial Public Offering.
Even though Initial Public Offering demands are on the rise among traders still, there are some downsides of investment in it.
So make sure you are already familiar with all these pointers that don’t stop you from investing in IPO but make you aware of the possible downfalls.
FAQs on Initial Public Offering
Here are the few FAQs on IPO –
Can anybody Invest in an IPO?
Any adult can start investing in an IPO. Still, in most instances, they must meet the qualifying requirements to participate in a company’s Initial Public Offering.
There are certain essential standards that an investor must adhere to. Here are the qualifying requirements:
- An investor looking to start trading in IPO must have a PAN card provided by the Income Tax department of India.
- It is not necessary to have a demat-cum-trading account. On the other hand, if a trader decides to sell the stocks listed on exchanges, he would need a trading account.
- A legitimate Demat account is also needed.
- As a beginner, if you are planning to invest in an IPO and this is the first time, it is general advice to open a trading account first in addition to a Demat account.
Is it Good to Buy Indian Public Offering?
A new IPO may comparatively have more demand in the market, but supply can be lower.
It happens because, in most instances, it isn’t clear that all buyers who are participating in an IPO investment would be able to buy shares.
Still, it is good to buy Indian Public offering as some of the brilliant startups and fastest-growing startups in India are evidencing the success rate of IPOs.
Investors can expect more opportunities in future of becoming the next billionaire in the world of trading.
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