Understanding IPOs: How to Invest in Initial Public Offerings

Keywords: IPOs, what is an IPO, IPO timelines, IPO process, Initial Public offerings, types of IPOs, benefits of investors, benefits of companies

Introduction

Hyundai Motors India’s IPO has shown exceptional interest of Investors, with an impressive subscription rate of 2.37 times for its public issue worth ₹27,870 crore. This makes it not only India’s largest IPO but also the second-largest in the world of all time. 

With all these news hype and numbers flying around, it’s no wonder that beginners are feeling a bit of FOMO (fear of missing out) and are curious about what is an IPO and how it works.

Addressing these questions, in this blog we’ll dig deeper into the world of IPOs: what they are, how they work, and why they matter for both companies and investors. Along with these, we will break down its different types and its significance. Let’s get into it.

What Is An IPO?

An Initial Public Offering, or IPO, is when a private company sells its shares to the public for the first time. This process allows the company to raise money by offering ownership stakes to individual and institutional investors. When a company goes public through an IPO, it transforms from being privately owned to publicly traded, meaning anyone can buy its shares on the stock market.

If simply explained, an IPO means that a company is moving from being privately owned to being owned by the public. That’s why we often say the company is “going public.”

Why Do Companies Go for an IPO?

Companies choose to go public for several reasons:

Raise Capital: By selling shares, a company can gather funds to expand its business, pay off debts, or invest in new projects. For example, if a tech startup wants to develop a new app, it might launch an IPO to raise the necessary funds.

Increase Visibility: Going public can boost a company’s profile and credibility. It often leads to more media attention and can attract new customers.

Provide Liquidity: An IPO allows early investors and company founders to sell some of their shares and cash out their investments.

What Are The Different Types of IPOs?

When a company decides to go public and sell its shares for the first time, it can choose from different types of IPOs. To select one, you need to understand both of these types carefully. Here are the two main types of IPOs:

Fixed Price Offering

In a fixed price offering, the company sets a specific price for each share before the IPO starts. No matter the hype or fuss, the price does not change.

How It Works: Investors know exactly how much they will pay for each share when they apply. For example, if a company sets the share price at ₹100, every investor pays ₹100 per share.

This method is straightforward and gives investors clarity and predictability. Investors know exactly how much they will pay. This method is popular in India because it provides transparency.

Book Building Offering

Investors know exactly how much they will pay. This method is popular in India because it provides transparency. This range includes a lower limit (floor price) and an upper limit (cap price).

How It Works: During the bidding period, 

investors can place bids within this range. For example, if the floor price is ₹90 and the cap price is ₹110, investors can choose how much they want to pay within that range.

This method allows the company to measure investor interest and set a final price based on demand. If many people want shares, the final price might be closer to the cap price.

Both types of IPOs have their advantages. A fixed price offering offers certainty, while a book building offering allows for flexibility and reflects market demand. 

The Cycle of an IPO: IPO Launch Process

Launching an Initial Public Offering (IPO) involves several steps. Let’s break down the process in simpler way:

1. Hire an Investment Banker

The first step in the IPO process is for the company to hire an investment banker. Think of this banker as a guide who helps the company easily go through the IPO launch journey. They help with everything from preparing important documents to marketing the IPO to potential investors. For example, if a popular Indian restaurant chain wants to go public, they might hire a well-known investment bank to assist them.

2. Prepare the Draft Red Herring Prospectus (DRHP)

Next, the company and the investment banker create a document called the Draft Red Herring Prospectus (DRHP). 

Contents: This document includes important information about the company, such as:

• Financial health (profits, losses)
• Business plans (how they plan to grow)
• Use of funds (how they will spend the money raised)

This document helps potential investors understand what they are investing in.

3. Get Approval from SEBI

Once the DRHP is ready, it needs to be submitted to SEBI (Securities and Exchange Board of India) for approval. SEBI checks that all information is accurate and that the company meets regulatory requirements. If everything looks good, SEBI gives the green light for the IPO to move forward.

4. Apply to Stock Exchanges

After receiving SEBI’s approval, the company applies to stock exchanges like the Bombay Stock Exchange (BSE) or National Stock Exchange (NSE) where it wants its shares to be listed. This step ensures that the company meets all listing requirements. 

This step ensures that the company meets all requirements to list its shares for trading.

5. The Underwriting Process

Now this is one of the crucial steps in the IPO launch process where investment banks help determine how many shares to sell and at what price.

Underwriters’ Role:

• They buy shares from the company and then sell them to the public.

• They help manage risk by guaranteeing a certain amount of money to the company.

This process helps ensure that the company raises enough funds, even if not all shares are sold.

6. Go on a Roadshow

Now comes an exciting part—the roadshow! The company’s executives travel around to meet potential investors and promote their upcoming IPO. They present facts and figures about their business and answer questions. This is their chance to create buzz and interest in their shares before they hit the market.

This is the step where company executives meet with potential investors, including anchor investors and QIIs to promote the IPO.

7. Price the IPO

Once interest is generated, it’s time to set a price for the shares. The company can choose between two methods:

• Fixed Price Offering: The price is set before shares are offered.

• Book Building: A price range is given, and investors can place bids within that range.

For example, if a tech startup sets its share price at ₹100, investors can decide how many shares they want at that price.

8. Launch the IPO

Finally, after all preparations are complete and pricing is set, the IPO is launched. Here comes the ‘Subscription Phase’ in the picture where investors, including RIIs (retail individual investors) and NIIs (non-institutional investors) show their confidence in the IPO. 

Investors can start placing bids for shares during a specified period (usually around 3-5 days). Once this period ends, shares are allocated based on demand. If more people want shares than are available (oversubscription), not everyone will get what they requested.

9. Shares Start Trading

After allocation, the shares are listed on stock exchanges and start trading publicly. This means anyone can buy or sell them in the market. For instance, if our restaurant chain goes public successfully, its shares will begin trading on BSE or NSE, allowing investors to buy in.

Benefits & Limitations for IPOs

Now, every IPOs have two parties involved – the investors and the companies. The companies seek to raise funds and investors their benefits. So here we have breakdown the benefits and limitations of engaging in these IPOs for both players:

Benefits of IPOs for Investors

Early Entry: Investors can buy shares when the company is first listed. If the company does well, the value of those shares might increase, leading to profit.

Potential for Growth: If you invest in a good IPO, your returns could grow over time as the company expands.

More Information: IPO companies provide detailed financial reports, making it easier to understand what you’re investing in.

Benefits of IPOs for Companies

Raise Money: Companies can gather funds for expansion by selling shares in the stock market. There could be various reasons such as launching new products, programs, or sister companies, depending on the company’s preferences. 

Build Trust: Going public helps companies gain more visibility and credibility among investors and customers. This also strengthens the confidence of customers and shareholders of the company.

Limitations of IPOs for Investors

Risk of Losses: Not all IPOs are profitable for investors. The news definitely creates the fuss, but in the end, there are times investors find themselves to discover a fool’s gold instead. Some may drop in value after listing, leading to losses.

Limited Control: Some IPOs may have restrictions that prevent you from selling shares immediately due to the lock-in period. 

Limitations of IPOs for Companies

Costs Involved: Preparing for an IPO can be expensive, with legal, marketing, and regulatory fees. Hence, companies need a major fund to back up their process. 

Public Pressure: After going public, companies have to disclose a lot of information, which brings more scrutiny from investors and the public.

How to Check for Upcoming IPOs?

If you’re interested in investing in upcoming IPOs, there are many ways to stay informed. Here’s how you can check for upcoming IPOs in a simple and straightforward manner:

Visit Financial News Websites: Websites like 5paisa, Moneycontrol, and Economic Times often provide updates on upcoming IPOs. They usually have dedicated sections that list upcoming issues along with details like the issue price and subscription dates.

Check Stock Exchange Websites: The Bombay Stock Exchange (BSE) and National Stock Exchange (NSE) maintain lists of upcoming IPOs. You can visit their websites to find official announcements and detailed information about each IPO.

Follow SEBI Announcements: The Securities and Exchange Board of India (SEBI) regulates IPOs in India. Keeping an eye on their announcements can help you learn about new companies planning to go public.

Use Online Brokerage Platforms: If you have an account with an online brokerage like 5paisa, Zerodha, or Upstox, you can log in to their platforms. They often have sections dedicated to current and upcoming IPOs where you can find all relevant information.

Social Media and Financial Blogs: Following financial experts on social media platforms or reading investment blogs can also keep you updated on upcoming IPOs. Many analysts share insights and news about new offerings.

Subscribe to Newsletters: Some financial websites offer newsletters that provide updates on market trends, including upcoming IPOs. Subscribing to these can give you timely information directly in your inbox.

Also Read: Understanding the Benefits of Holding Stocks for the Long Term

What is An IPO Timeline?

The timeline for an Initial Public Offering (IPO) outlines the key steps a company goes through to become publicly traded. Here’s a simplified breakdown of the typical IPO timeline:

• Preparation Phase: Several months before the IPO
• SEBI Approval: A few weeks to months
• Marketing Phase (Roadshow): 1-2 weeks
• Price Setting: Just before the IPO launch
• IPO Launch: Typically lasts 3-5 days
• Allotment of Shares: A few days after the bidding ends
• Listing on Stock Exchanges: Usually within a week after allotment

In Essence

Understanding IPOs is crucial for both beginners and experienced investors. IPOs offer a unique opportunity to invest in a company during its early public stages, but they come with both benefits and risks. Not every IPO is great, hence to avoid getting into scam deals, always study the company’s fundamentals before investing. IPOs can be volatile; invest only what you can afford to lose.

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