What is IPO? – A Complete Beginner’s Guide
If you’ve ever heard about companies like Zomato, Nykaa, or LIC “going public” and wondered what that means, you’re in the right place. An Initial Public Offering (IPO) is one of the most significant milestones in a company’s journey, transforming it from a privately held entity to one whose shares can be bought and sold by everyday investors like you.
In this comprehensive guide, we’ll break down everything you need to know about IPOs—from the basic definition to the step-by-step process, real-world examples, benefits, risks, and key terms that will help you navigate the exciting world of public offerings.
Definition of IPO (Initial Public Offering)
An IPO, or Initial Public Offering, is the process through which a private company offers its shares to the general public for the first time. When a company “goes public” through an IPO, it lists its shares on a stock exchange, allowing retail and institutional investors to become partial owners by purchasing these shares.
Before an IPO, a company is privately owned by its founders, early investors, venture capitalists, or private equity firms. After an IPO, anyone with a trading account can buy shares, making the company publicly traded.
IPO meaning in simple terms: Think of an IPO as a company opening its doors to new partners. Instead of being owned by a small group of people, the company invites the public to invest money in exchange for ownership shares. This money helps the company grow, expand operations, or pay off debts.
Why Do Companies Go for an IPO?
Companies choose to go public for several strategic reasons:
Business Growth and Expansion
An IPO provides companies with substantial capital that can be used to expand operations, enter new markets, invest in research and development, or acquire other businesses. This influx of funds doesn’t need to be repaid like a bank loan, giving companies more financial flexibility.
Raise Capital from Public Markets
Going public allows companies to tap into a vast pool of capital from millions of potential investors. This is often more capital than they could raise through private funding rounds or bank loans. The funds raised can be used for working capital, infrastructure development, or reducing existing debt.
Brand Visibility and Credibility
Being listed on a stock exchange significantly enhances a company’s brand recognition and credibility. Public companies are subject to greater scrutiny and regulatory oversight, which can increase trust among customers, suppliers, and business partners. The media coverage surrounding an IPO also provides valuable publicity.
Liquidity for Early Investors and Employees
An IPO creates a market for shares, allowing early investors, founders, and employees holding stock options to sell their shares and realize gains. This liquidity event rewards those who took early risks with the company.
Currency for Acquisitions
Publicly traded shares can be used as currency for acquiring other companies. Instead of paying cash, a public company can offer its shares in exchange for the target company, preserving cash reserves.
How an IPO Works (Step-by-Step IPO Process)
The journey from a private company to a publicly traded one involves multiple stages and can take several months to complete. Here’s a detailed breakdown of the IPO process:
Pre-IPO Planning
The company’s management and board of directors decide to pursue an IPO and appoint investment banks (also called underwriters) to manage the process. These banks help determine the IPO’s feasibility, size, pricing, and timing. The company also assembles a team of lawyers, auditors, and consultants to ensure compliance with regulatory requirements.
During this phase, the company undergoes due diligence, where its financial statements are audited, and its business model is thoroughly examined. The company must also ensure its corporate governance structures meet public company standards.
Regulatory Filings
In India, companies must file a Draft Red Herring Prospectus (DRHP) with the Securities and Exchange Board of India (SEBI). This document contains detailed information about the company’s business, financials, management, risks, and the purpose of the IPO.
In the United States, companies file an S-1 registration statement with the Securities and Exchange Commission (SEC). Regulatory bodies review these documents to ensure all necessary information is disclosed to potential investors.
Book Building and Price Range
The company and its underwriters conduct a book building process to gauge investor interest and determine the IPO price range. They organize roadshows where management presents the company’s vision and financials to institutional investors.
Based on demand, a price band is set—for example, shares might be offered between ₹100 to ₹110 per share. Investors submit bids within this range, and the final price is determined based on demand.
IPO Subscription
Once regulatory approval is received, the IPO opens for subscription. Retail investors, institutional investors, and high-net-worth individuals can apply for shares through their broker or bank accounts.
The subscription period typically lasts 3-5 days. During this time, investors specify how many shares they want and at what price (within the price band). The subscription can be oversubscribed (demand exceeds supply) or undersubscribed (insufficient demand).
Allotment and Listing
After the subscription period closes, shares are allotted to investors based on the allocation methodology. For oversubscribed IPOs, retail investors typically receive shares through a lottery system to ensure fair distribution.
Allotted investors receive shares in their demat accounts, and refunds are processed for those who didn’t receive allocation or for excess amounts paid. Finally, the company’s shares are listed on the stock exchange, and trading begins on the listing day.
The listing price may be higher or lower than the IPO price, depending on market demand and sentiment.
IPO Example (Case Study)
Let’s look at a real-world example to understand how IPOs work in practice.
Zomato IPO (2021)
Background: Zomato, India’s leading food delivery platform, went public in July 2021, marking one of the most anticipated tech IPOs in the country.
IPO Details:
- Price Band: ₹72 to ₹76 per share
- Issue Size: ₹9,375 crore
- Subscription Status: Oversubscribed 38.25 times
- Final Issue Price: ₹76 per share
Timeline and Outcomes: The IPO opened for subscription on July 14, 2021, and closed on July 16, 2021. Given the massive investor interest, the issue was heavily oversubscribed, particularly in the retail category.
Shares were allotted on July 21, 2021, and the company listed on BSE and NSE on July 23, 2021. The listing price was ₹116 per share, representing a 52.6% premium over the issue price—a strong debut that rewarded IPO investors.
First Day Performance: On the first day of trading, Zomato shares closed at ₹125.85, giving investors who were allotted shares at ₹76 a gain of approximately 65% on the listing day.
This example illustrates how IPOs can provide significant opportunities, but it’s important to note that not all IPOs perform this well, and some may list below their issue price.
Benefits of Investing in an IPO
Investing in IPOs can offer several advantages, especially if you identify promising companies early:
Early Access to Growth Opportunities
IPOs allow you to invest in companies at the ground level of their public journey. If the company grows substantially after listing, early investors can benefit from significant capital appreciation.
Potential Long-Term Gains
Many successful companies that went public years ago have generated substantial returns for IPO investors. Companies like Amazon, Google, and in the Indian context, Infosys and HDFC Bank, have created enormous wealth for those who invested in their IPOs and held on to their shares.
Portfolio Diversification
IPOs often come from emerging sectors or innovative business models, providing opportunities to diversify your investment portfolio beyond established companies.
Transparent Pricing
The IPO process involves extensive disclosures and regulatory oversight, giving investors access to comprehensive information about the company before investing.
Allocation Benefits for Retail Investors
Many markets, including India, reserve a portion of IPO shares specifically for retail investors, ensuring they get fair access to new offerings alongside institutional players.
Risks and Challenges of IPO Investing
While IPOs can be exciting, they come with significant risks that investors must understand:
Price Volatility
Newly listed stocks often experience high volatility as the market determines their fair value. Prices can swing dramatically in the initial days or weeks of trading, potentially leading to losses if you need to sell during a downturn.
Lock-in Periods for Insiders
Founders, early investors, and employees typically face lock-in periods (often 6-12 months) during which they cannot sell their shares. When these lock-in periods expire, the sudden increase in supply can put downward pressure on the stock price.
Limited Historical Data
Unlike established public companies, IPOs have limited trading history and market-tested valuations. This makes it harder to assess whether the IPO price represents good value.
Overhype and Overvaluation
Popular IPOs can be overhyped by media coverage and market excitement, leading to inflated valuations. When reality doesn’t meet expectations, stock prices can decline sharply.
Market Conditions Matter
IPO performance is heavily influenced by overall market sentiment. Even good companies may struggle if they list during market downturns or economic uncertainty.
No Guarantee of Allotment
Oversubscribed IPOs use lottery systems for retail allocation, meaning you may not receive shares even if you apply. Your money remains blocked during the allotment process, creating an opportunity cost.
Key IPO Terms Every Investor Should Know
Understanding IPO terminology will help you navigate offerings more confidently:
Book Building
This is the process of price discovery where the company and underwriters collect bids from investors to determine the final IPO price. Investors bid within a specified price range, and the final price is set based on demand.
Grey Market Premium (GMP)
The grey market is an unofficial market where IPO shares are traded before they’re officially listed. The Grey Market Premium indicates the expected listing price premium over the issue price. While GMP can provide insights into market sentiment, it’s not regulated and should be viewed cautiously.
Allotment Ratio
When an IPO is oversubscribed, not everyone receives the shares they applied for. The allotment ratio indicates how shares are distributed—for example, a 1:10 ratio means one share is allotted for every ten applied for.
Listing Premium/Discount
The difference between the IPO issue price and the price at which shares begin trading on the exchange. A listing premium means shares debut above the issue price, while a listing discount means they open below it.
Anchor Investors
Institutional investors who commit to buying shares before the IPO opens to the general public. Their participation signals confidence and can help generate momentum for the offering.
Red Herring Prospectus
A preliminary prospectus that contains most IPO details except the final price and share quantity. It gets its name from the red text used for disclaimers in early versions.
Underwriter
Investment banks or financial institutions that manage the IPO process, help set pricing, market the offering, and often guarantee to purchase unsold shares.
Offer for Sale (OFS)
When existing shareholders sell their stakes through the IPO. This differs from a fresh issue where the company issues new shares to raise capital.
FAQs About IPOs
What’s the difference between IPO and FPO?
An IPO (Initial Public Offering) is when a company offers shares to the public for the first time. An FPO (Follow-on Public Offering) occurs when an already listed company issues additional shares to raise more capital. The key difference is that IPOs represent a company’s stock market debut, while FPOs are subsequent offerings by companies already trading publicly.
How are IPO shares allotted?
The allotment process depends on subscription levels. If the IPO is undersubscribed, all applicants receive their requested shares. For oversubscribed IPOs, retail investors are typically allotted shares through a computerized lottery system to ensure fair distribution. Institutional and high-net-worth investor categories may receive proportionate allotments based on their bids.
Can retail investors apply for IPO?
Yes, retail investors can absolutely apply for IPOs. In India, SEBI mandates that at least 35% of shares in an IPO must be reserved for retail individual investors (those applying for shares worth up to ₹2 lakh). This ensures everyday investors get fair access to new offerings alongside large institutional players.
What is the minimum investment required for an IPO?
The minimum investment varies by IPO but is typically one lot. A lot consists of a specified number of shares set by the company. For example, if the lot size is 140 shares and the price is ₹100 per share, the minimum investment would be ₹14,000.
How long does my money remain blocked during IPO application?
When you apply for an IPO using the ASBA (Application Supported by Blocked Amount) facility, the application amount is blocked in your bank account until allotment. Typically, this is 7-10 days from the closing date. After allotment, the amount for allotted shares is debited, and the remaining amount is unblocked.
Can IPO shares be sold immediately after listing?
Yes, once shares are credited to your demat account and trading begins on the exchange, you can sell them immediately. There are no mandatory holding periods for regular IPO investors. However, company insiders and anchor investors typically face lock-in restrictions.
Final Thoughts
Understanding what an IPO is and how the process works empowers you to make informed investment decisions when companies go public. While IPOs can offer exciting opportunities for early-stage investment in growing companies, they also carry risks that shouldn’t be overlooked.
Before investing in any IPO, thoroughly read the prospectus, understand the company’s business model and financials, assess the valuation, and consider how it fits into your overall investment strategy and risk tolerance. Not every IPO is a good investment, and past performance of other IPOs doesn’t guarantee future results.
Whether you’re a beginner exploring the stock market or an intermediate investor looking to participate in public offerings, approaching IPOs with knowledge, patience, and realistic expectations will serve you well in your investment journey.
