An Initial Public Offering (IPO) is a crucial event in the financial market. It marks the first time a privately-held company offers shares to the public, transforming from a private entity into a public one. For investors, IPOs provide an opportunity to own a part of a growing company, while for the company itself, an IPO is a way to raise capital for expansion, pay off debt, or fund other business operations. In this blog, we’ll explore what an IPO is, how it works, and how you can apply for one.

What is an IPO?

An Initial Public Offering (IPO) is when a private company offers its shares to the public for the first time. This process allows the company to raise funds from individual and institutional investors. It also marks the company’s transition from being privately owned (typically by a small group of investors, founders, and possibly venture capitalists) to being publicly owned, where its shares are traded on a stock exchange.

Why Do Companies Go Public?

There are several reasons why companies choose to go public through an IPO:

1. Capital Raising: The primary purpose of an IPO is to raise capital. This capital can be used for business expansion, research and development, acquisitions, or paying off debt.
2. Enhanced Credibility: Going public increases a company’s visibility and credibility in the market. It often leads to greater public trust, which can positively affect sales and partnerships.
3. Liquidity for Shareholders: An IPO provides liquidity to early investors (like venture capitalists or founders), allowing them to cash out part or all of their investments in the company.
4. Employee Benefits: By going public, companies can offer stock options to their employees as part of compensation packages. This can help attract and retain top talent.
5. Valuation: A public offering helps determine the company’s market value, allowing for easier mergers and acquisitions.

How Does an IPO Work?

The IPO process is intricate and involves several stages. Below is an overview of the steps companies go through before offering shares to the public.

1. Selecting Underwriters

Before launching an IPO, a company selects an underwriter, typically an investment bank or a consortium of banks. These underwriters help the company prepare for the IPO by determining the price, managing regulatory requirements, and marketing the shares to potential investors. Underwriters play a critical role in ensuring that the company raises the desired amount of capital while also protecting the interests of investors.

2. Filing with Regulatory Authorities

In most countries, companies must file detailed documentation with regulatory bodies such as the Securities and Exchange Commission (SEC) in the United States or the Securities and Exchange Board of India (SEBI). This document, commonly referred to as a prospectus or Red Herring Prospectus (RHP), provides a detailed overview of the company’s financial health, risks, business model, management team, and more. It’s crucial for potential investors to study this document to understand the company they’re investing in.

3. Pricing the IPO

Pricing an IPO is a critical step. The company, along with its underwriters, determines a price band (a range within which the final price will fall) based on factors like the company’s valuation, market conditions, and investor demand. The final price is typically set based on the response received from institutional investors during a process called book building.

4. IPO Launch

Once the price is set, the IPO is launched. Investors can apply for shares during a specified subscription period, usually lasting a few days. During this period, investors place bids at a specific price within the price band.

5. Share Allotment

After the subscription period closes, the company allots shares based on the demand. In the case of oversubscription (when the number of applications exceeds the shares available), shares are often allotted on a pro-rata basis, or through a lottery system.

6. Stock Market Listing

Once the IPO is completed, the company’s shares are listed on a stock exchange, such as the New York Stock Exchange (NYSE) or the Bombay Stock Exchange (BSE). Investors can then buy and sell the stock in the secondary market.

How to Apply for an IPO

Now that you understand what an IPO is, the next question is: how do you apply for an IPO?

The application process has become much more accessible with the rise of online platforms and trading accounts. Here’s a step-by-step guide on how to apply for an IPO:

1. Open a Demat and Trading Account

Before you can apply for an IPO, you need to have a Demat account (to hold your shares) and a trading account (to buy and sell shares). These accounts can be opened with a bank or a stock brokerage firm. Some well-known brokers include Zerodha, Robinhood, and TD Ameritrade. Ensure that the brokerage platform supports IPO applications.

2. Log into Your Trading Platform

Once your Demat and trading accounts are set up, log into your broker’s trading platform. Most online brokers have a dedicated IPO section where you can find a list of upcoming and ongoing IPOs.

3. Select the IPO You Want to Apply For

Browse through the available IPOs and select the one you wish to invest in. You’ll usually see key details like the company name, price band, issue size, and closing date of the IPO. Make sure to thoroughly research the company and its prospectus before investing.

4. Place Your Bid

When applying for an IPO, you will be required to place a bid. This includes specifying:

• Number of shares you want to buy.
• Price at which you wish to apply within the specified price band.

For retail investors, there’s typically a limit to how much you can invest. This limit differs across countries, but in India, for instance, the cap is usually ₹2,00,000.

You can also choose to place a cut-off price bid, which indicates that you are willing to pay the highest price within the price band.

5. Complete Payment

Once the bid is placed, the money required to buy the shares is blocked in your bank account using the ASBA (Application Supported by Blocked Amount) process. This is a secure method used in many countries, where the money is held in your account until the shares are allotted, at which point the amount is debited. If you don’t get the shares (in case of oversubscription), the blocked amount is released back into your account.

6. Wait for Allotment

After the subscription window closes, the company will allot shares to successful bidders. If the IPO is oversubscribed, some investors may not receive the full number of shares they applied for. The shares are allotted through a lottery system or on a proportional basis.

Once the shares are allotted, they will be credited to your Demat account, and you can trade them on the stock exchange when the company gets listed.

7. Trading the Shares Post-IPO

Once the company is listed on the stock exchange, you can buy or sell the shares in the secondary market. Depending on market conditions and demand, the share price may fluctuate significantly after listing.

Things to Consider Before Applying for an IPO

While IPOs offer an exciting investment opportunity, they also carry risks. Here are a few things to keep in mind before applying for an IPO:

1. Research the Company: Always study the company’s prospectus to understand its business model, financials, growth potential, and risks.
2. Market Conditions: The overall stock market environment can influence an IPO’s success. If the market is volatile or bearish, it might affect the company’s stock performance post-listing.
3. Lock-in Period: Some IPOs come with a lock-in period, especially if you’re investing in a company’s shares as an anchor investor. This period restricts you from selling the shares immediately after the listing.
4. Overvaluation: IPOs can sometimes be overhyped, leading to overvaluation. Make sure you’re not overpaying for the shares just because there’s excitement around the offering.
5. Company’s Future Prospects: Assess whether the company has a strong management team, competitive advantages, and a clear path for growth before investing.

Conclusion

An IPO represents an opportunity for investors to get in on the ground floor of a company’s public journey. By buying shares at the IPO stage, you can become a part-owner of the business and potentially benefit from its future growth. However, as with all investments, it’s essential to conduct thorough research and understand the risks involved.

Applying for an IPO has become easier with online platforms, allowing retail investors to participate in the process with just a few clicks. Whether you’re a seasoned investor or a novice, understanding the IPO process, along with its benefits and risks, will help you make informed investment decisions.

Investing in IPOs can be rewarding, but it’s important to balance optimism with due diligence. By doing your homework, keeping an eye on market conditions, and understanding the company’s fundamentals, you can maximize your chances of success when applying for an IPO.