IPOs stand for Initial Public Offerings and are known for their amazing returns opportunities. While they are considered to be a well-saught-after investment avenue, before you step ahead with an investment in an IPO, it is important that you first understand what an IPO is and how it functions.
Understanding IPOs
Initial Public Offering or IPO is the offering that a private company makes by opening its shares to the public for the first time. This is also known as the company’s call for “going public”. An IPO is a strategic move taken by private sector companies to raise funds and capital by allowing the public to purchase the company’s shares. IPO is considered a major step for the company as it decides to set foot in the stock market.
Different Types of IPOs
IPOs are majorly classified into two types and both IPO types play a critical role in the stock market. Let’s take a look:
- Fixed Price Offering
As the name suggests, fixed price offering is the type of IPO where the company pre-decides the price of their stocks before opening it to the market. Here, the investors come to know the share price only when the company announces it. Also, the share prices remain the same throughout the IPO. Deciding the price of a share is crucial for the company as it depends on the funds that the company can raise.
- Book Building Offering
Book building offering is the other IPO type. Here the company does not determine the price of their shares. Instead, they set a price range for stocks and put it in the market for investors to bid. Under the price bracket, there are two fixed prices- floor price (lower limit) and cap price (upper limit). This allows the company to gauge the market trend first and then finalise the price.
How does an IPO work?
IPO is a big step for the company and it involves equal amounts of risks as the chances of profits and raising desirable funds. This is why companies rely on experts to follow a detailed process before and after introducing their IPO. To understand the process of IPO, we have listed down the major steps involved-
- Preparation
Since an IPO is a major step the company focuses on conducting deep research to evaluate all the pros and cons of going public. This includes months of discussion with finance and trading experts. - DRHP filing
According to SEBI, any company planning to go public has to file DRHP. DRHP stands for Draft Red Herring Prospectus featuring details and terms and conditions of their company and shares. - Stock exchange portal
IPO is a process that allows the company to raise funds which means it is equally important to choose a stock exchange portal wisely. Stock exchange portals have varying policies, fees and traffic that play a vital role in deciding the fate of shares. - Roadshow and pricing
Before making the company’s share public, the company along with underwriters do a roadshow i.e. advertising the IPO to gauge the market. Based on the observation, the company decides the percentage of shares they wish to make public and the price. At this stage, the company has to issue a final Red Herring Prospectus featuring the final pricing. - Allocation and listing
Once the price is finalised, the shares are allocated to multiple investor categories including Non-Institutional Investors and Retail Individual Investors. This allows the bidders to apply for the shares in the given period. - Listing
The final step in an IPO is listing where the company’s shares are listed on stock exchange portals.
Once these steps are done, the day for commerce comes when the shares are purchased and sold for the company to raise funds. Additionally, the companies have to keep updating the investors and stock exchange portals about financial changes.
Wrapping Up
In India, IPO is guided by SEBI which mandates the companies to follow strict rules and regulations. This is done to ensure fair dealing in the stock market and protect the investors from getting scammed under pretences. Investing in an IPO has its set of pros and cons but it has gained popularity over the years with reputed private companies coming in the playfield. Make sure you weigh the pros and cons before making a decision.