Initial Public Offerings (IPO)

The IPO full form is Initial Public Offering. It’s when a private company sells shares to the public for the first time, becoming publicly traded to raise funds.
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Initial Public Offerings (IPO)
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3 mins read
08-March-2025

An Initial Public Offering (IPO) is when a private company sells its shares to the public for the first time to raise equity capital. This process turns a private company into a public one, allowing investors to buy shares and potentially benefit from its growth.

Investing in IPOs can be rewarding if you make informed decisions, but not every IPO is a great opportunity. It’s important to understand the basics first.

What is Initial Public Offerings (IPO)

The IPO full form is Initial Public Offering. It’s when a private company sells shares to the public for the first time to raise capital. This makes it a publicly traded company, allowing investors to buy shares and benefit as it grows. The funds raised help in business expansion.

It is a key step in a company’s growth, allowing it to raise funds by selling shares to institutional investors, high-net-worth individuals (HNIs), and the general public.

Once the IPO is complete, shares can be freely traded on the stock market. This process not only helps businesses secure capital for expansion but also provides investment opportunities and allows early investors to gain returns.

Types of IPO

There are two common types of IPO:

1. Fixed price offering

A fixed price issue is a straightforward approach to setting the price of shares before they are offered to the market. This method involves the company determining a fixed price per share, which remains constant throughout the IPO process. To establish this price, the company collaborates with financial experts like merchant bankers and underwriters.

Fixed-price offerings have traditionally been favoured by Indian businesses for capital raising. Investors appreciate this type of IPO due to its transparency. They have clarity on the exact price per share they will pay, providing reassurance to those who prioritise predictability in their investments.

2. Book building offering

In contrast to fixed price issues, book building offers a more dynamic approach to determining share prices. In this method, the company sets a price range or band within which investors can bid for shares. This range includes a lower limit known as the 'floor price' and an upper limit called the 'cap price.'

During the bidding phase, investors submit bids within this specified range, indicating the quantity they wish to purchase and the price they are willing to pay. This mechanism allows the company to gauge investor interest and finalise the share price based on the demand received.

Book-building issues are gaining popularity in India due to their flexibility and ability to accurately reflect market demand. It empowers investors to influence the final price based on their willingness to pay, thus aligning the pricing with market dynamics effectively.

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How IPO works?

In an IPO, a company decides to raise capital by issuing shares of its stock to the public. Here's how the process typically works:

1. Preparation phase

  • A company decides to go public and appoints investment banks as underwriters.
  • Extensive due diligence, including financial audits and legal compliance checks, is conducted.

2. DRHP filing

The company files a Draft Red Herring Prospectus (DRHP) with the Securities and Exchange Board of India.

3. Select the stock exchange

The next step would be to decide the exchange where the company would list its shares should be made, followed by an application to the selected exchange.

4. Roadshow

The company, along with underwriters, conducts a roadshow to promote the IPO to potential investors.

5. Pricing

  • Based on investor demand and market conditions, the offering price is determined.
  • The final prospectus, known as the Red Herring Prospectus (RHP) is issued with the offer price range.

6. Allocation

  • Shares are allocated to various investor categories, including Qualified Institutional Buyers (QIBs),, Non-Institutional Investors, and Retail Individual Investors.
  • Bidders can apply for shares within the specified price range.

7. Listing

The company's shares are listed on stock exchanges like NSE and BSE.

8. Trading commences

  • On the IPO day, the shares become available for trading in the secondary market.
  • Investors can buy and sell shares at market prices.

9. Lock-up period

Promoters and certain shareholders are often subject to lock-up periods during which they cannot sell their shares.

10. Post-IPO reporting

The company is required to provide regular financial and operational updates to the stock exchanges and investors.

11. Stabilisation period

In some cases, underwriters may engage in stabilisation activities to support the stock's price during the early trading period.

The IPO process in India involves rigorous regulatory compliance and thorough investor scrutiny to ensure transparency and fairness in the capital markets.

Advantages and disadvantages of investing in IPO

Investing in an IPO provides early access to promising companies and potential high returns. However, it also carries risks like volatility, limited history, and market fluctuations. Understanding its advantages and disadvantages is crucial before investing.

Advantages

Disadvantages

Early investment opportunity – Allows investors to participate in a company’s growth at an early stage.

High risk – Newly public companies may lack a proven track record, leading to uncertainty.

Potential for high returns – Successful IPOs can lead to significant capital appreciation.

Volatility – IPO share prices can be highly volatile, especially in the initial trading phase.

Access to promising companies – Enables investment in innovative companies that were previously private.

Limited historical information – Investors may have limited access to financial data, making due diligence challenging.

Liquidity for founders & early investors – Allows early shareholders to monetise their holdings.

Potential for overvaluation – Some IPOs may be overpriced, leading to price corrections.

Market visibility – Enhances company reputation and credibility, benefiting business growth.

Lock-up periods – Restrictions on early investors from selling shares may impact supply-demand dynamics.

 

Terms associated with IPO

Here are some of the important terms associated with IPO:

Underwriter

Third parties such as a banker, financial institution, or a broker hired by the company to assist with underwriting the stocks.

Fixed price IPO

Fixed Price IPO refers to a predetermined issue price set by companies for the initial sale of their shares.

DRHP

DRHP stands for Draft Red Herring Prospectus. It is a preliminary document filed by a company to the SEBI when it is planning to issue an IPO.

Book building

Book building refers to the process where underwriters or merchant bankers determine the price at which IPOs will be offered.

Issuer

The issuer is the company that is offering its shares to the public for the first time through an Initial Public Offering (IPO). It's the entity that seeks to raise capital by selling a portion of its ownership to public investors.

Price band

Price band refers to a range within which the price of shares offered in an IPO can be bid for by investors. It's set by the issuer and is mentioned in the offer document. Investors can bid for shares within this specified range.

Undersubscription

Undersubscription occurs when the demand for shares in an IPO is less than the number of shares offered by the company. In other words, not enough investors are interested in buying the shares at the offered price or within the price band.

Oversubscription

Oversubscription happens when the demand for shares in an IPO exceeds the number of shares offered by the company. In such cases, there are more investors willing to buy shares at the offered price or within the price band than there are shares available.

Green shoe option

Also known as the over-allotment option, it is a provision that allows underwriters to sell additional shares beyond the original number offered by the issuer in an IPO. This option helps stabilise the stock price by allowing the underwriters to purchase additional shares at the offering price if demand exceeds expectations.


Things to remember while investing in an IPO

When considering investing in an IPO, it's essential to keep the following factors in mind:

1. Research the company

Thoroughly study the company's background, financial health, and future prospects before making an investment in the IPO. Understanding the business and its potential for growth is crucial.

2. IPO locking period

Take note of the IPO locking period. This period restricts your ability to sell or trade the IPO shares immediately after the initial investment. Be aware of the duration of this lock-in period.

3. Investment strategy

Always have a well-defined investment strategy in place before participating in any IPO. Determine your financial goals, risk tolerance, and how the IPO fits into your overall portfolio. Planning your investment approach is essential for making informed decisions and managing your investment effectively.

Conclusion

Investing in an IPO can be an exciting opportunity to participate in the growth of a company from its early stages. However, it comes with risks, and thorough research and consideration of various factors are essential. By understanding the IPO process, evaluating companies, and using reliable platforms like Bajaj Financial Securities Limited, you can make informed investment decisions in the dynamic world of IPOs.

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Frequently asked questions

What is the full form of IPO?

IPO stands for Initial Public Offering. It marks the first instance of a company offering its shares to the public to raise capital from institutional and retail investors.

Is IPO profitable?

IPOs can be profitable as they offer opportunities to invest in companies at an early stage. If the company performs well, investors can achieve significant returns with relatively lower risk compared to other investment options.

How to sell IPO shares?

IPO shares can be sold on the listing day with specific trading windows:

  • Orders can be placed from 9:00 AM to 9:45 AM.
  • There is a freeze period from 9:45 AM to 9:59 AM.
  • Normal trading starts at 10:00 AM, allowing investors to place, modify, or cancel orders.

Is IPO a stock or a share?

IPO is not a stock or a share, but a process by which a company becomes a public company by offering its shares for public purchase in a new stock issuance.

How is an IPO priced?

The price of an IPO is determined by the company and its advisors, who set an initial price for the offering based on market demand and supply.

How is IPO profit calculated?

The profit from an IPO depends on the difference between the issue price and the listing price of the shares. The profit can be calculated by subtracting the issue price from the listing price and multiplying the result by the number of shares allotted.

What is an IPO in simple terms?

An IPO, or Initial Public Offering, is when a private company first sells shares of ownership (stock) to the public on a stock exchange. This allows them to raise money for growth by giving investors a stake in the company.

Is it good to buy in an IPO?

Investing in Initial Public Offerings (IPOs) presents a compelling opportunity to diversify your investment portfolio with high-quality stocks. While IPOs can exhibit short-term volatility, adopting a long-term investment perspective significantly enhances the likelihood of achieving substantial returns.

Who can invest in IPOs?

It depends on your brokerage and the IPO itself. Typically, retail investors can participate, but allocations can be limited. Big institutions often get first dibs. Check with your broker for details.

What is IPO in stock market?

An Initial Public Offering (IPO) is the first sale of stock by a private company to the public. This allows the company to raise capital and become a publicly traded entity. Investors can then buy and sell these shares on the stock market.

Is IPO better than shares?

There's no definitive answer as to whether IPOs are better than shares. IPOs can offer potential for high returns, but they also come with increased risk. It's essential to conduct thorough research and consider factors like the company's financial health, industry trends, and your risk tolerance before investing in an IPO.

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