What is IPO and its types. How to apply in IPO in the stock market, Meaning, Types, Working & Benefits and how IPO works

Have you heard about IPOs? That’s an important aspect of finance. The acronym stands for Initial Public Offerings. In short, it is how a private company chooses to open its doors to the rest of the public by selling shares for the first time on a stock exchange. An IPO is like a grand opening for a company: an important event that vaults it from being privately held to publicly traded status.

An IPO is significant because it represents more than a stock option – it is an opportunity for both the company and prospective investors. IPOs are a fairly unique experience: offering potential investors a limited chance to buy shares in a young company with promising prospects before they embark on a journey of possibly remarkable success. That said, like all other experiences that include an adventure, an IPO has its own thrills, twists, and turns to consider. Understanding what an IPO is, how it operates, and the different types of IPOs provides (within reason) a better understanding before making decisions. Before playing the game, a good player should have some perception of the rules.

What is an IPO?

An Initial Public Offering (IPO) is the first time a private company sells share stock to the investing public on a stock exchange and thus becoming a public company. Think of it as the first introduction of a company to the stock exchange. Before the IPO happened, ownership of the company was limited to a restricted group of individuals (such as the founders of the company and some private investors). By “going public”, the company raises large amounts of money from public investors that are interested in investing with the potential to grow their investments to fund growth, pay off debt, or other expansion opportunities. In return, the individuals who make the purchase become part owners of the company. Therefore, going public is a significant financial investment that formally changes a privately-held company into a public and investor-held company.

Types of IPO

Fresh Issue:

• In this case, the company issues new shares and offers them to the public.
• With the sale of the new shares, the proceeds go to the company.
• The company will use this capital to pursue their growth objectives, such as expanding business operations, building new facilities, funding research, or paying down debt.
• This does not consider the sale of shares already held by existing shareholders.

Offer for Sale (OFS):

• In this instance, the current shareholders (e.g. promoters, founders, or early private investors) market a share of their existing shares to the public.
• The proceeds of such a sale are received by the stakeholders selling their shares, not by the company.
• It provides an “exit route” for early investors to look to cash out a portion of their shares.
• Many I.O.’s are a combination of both a Fresh Issue i.e., new shares sold to the public and an Offer for Sale.

Fixed Price Issue:

• The firm establishes a predetermined price at which the stock is to be sold to investors.
• Investors have knowledge of the share price to which they are applying.
• The demand for the stock (the level of oversubscription) is not known until after the issue is closed.

Book Building Issue:

• This is the more prevalent approach being used today.
• Instead of a set price, the issuer announces a price range (for example, ₹500 to ₹550 per share).
• Investors place bids within this range, letting the issuer know what shares they want and what price they are willing to pay.
• When the bidding is over, the final cut-off price is determined based on the demand at various price points.
• This ensures the company finds out what the best market price for the shares would be.

How IPO Works

Hiring the Experts (Investment Banks):

• The company engages one or more investment banks (called “underwriters” or “placement agents”) to oversee the entire process. These banks are specialists who will provide some expertise to the company, assist in setting the share price, and take the legal responsibility of selling the shares to the public.

Due Diligence and Drafting the Red Herring Prospectus (DRHP):

• Next, the bankers perform a deep dive into the company’s operations, known as “due diligence.”
• In combination with the due diligence review, the bankers prepare a very detailed document, called the Draft Red Herring Prospectus (DRHP). The DRHP serves as both a resume and a report card for the company, containing key details such as the company’s financial data, the rationale for raising money, the business risks, and the anticipated use of the funds raised. The DRHP is submitted to the market regulator (in India, that is SEBI) for approval.

Pricing the Shares:

• The business and bankers agree on a price range for the shares (e.g. ₹500 to ₹550). This is part of the “book building” process in which they seek opinions from large institutional investors to set a reasonable price.

Marketing the IPO (Roadshow):

• The management of the company and their bank advisors travel the country on a “roadshow.” They present their business plan to potential large investors (such as mutual funds and insurance companies) and seek to persuade them to invest and get excited about the business.

The Public Offering (Bidding/Application):

• When the regulator grants its approval, the IPO opens for a brief period of time (typically 3-4 days). At this point, you, the retail investor, may request shares through your bank or brokerage account.

Allotment of Shares:

• Once had the bidding period has ended, the bankers and the company will confirm the cut-off price (the effective price at which shares are sold) based on all the bids collected.
• If the IPO is oversubscribed (more investors applied for shares than there are available), shares are allocated in a fair manner, usually prioritizing small retail investors. You may not obtain all the shares you applied for, you may only obtain a portion of them or in some cases you will not receive any shares at all.

Listing on the Stock Exchange:

• Lastly, shares of the company are offered a formal listing on a stock exchange (such as NSE or BSE in India). The day is referred to as the “listing day,” and the shares will begin to trade in earnest with the public.
• At this point, the price of the shares floats on the basis of supply and demand. The price may trade above or below the Initial Price Offering (IPO) price depending on the market’s assessment of the company.

How to Apply for an IPO in India

Step 1: Get the IPO Details

• Identify the IPO to which you wish to apply. Important details to consider:
  • Price Band: The range (example: ₹400 – ₹420) in which you can place a bid.
  • Lot Size: The minimum amount of shares for which you must apply (example: 1 lot = 15 shares). You can apply for multiples of the lot size only.
  • Dates: The date of the opening and closing of the application.

Step 2: Apply Through Your Broker (Online) – The Easiest Way

• Access your trading account through your broker (e.g., Zerodha, Angel One, ICICI Direct, etc.) or login to your bank’s net banking site.
• Find the section labelled “IPO” or “Apply for IPO”.
• Choose the IPO you wish to apply for.

Step 3: Fill the Application Form

• Category of Investor: Select the applicable category, which, for most individual applicants, is “Retail Individual Investor (RII)” (An RII is someone applying for shares, which total less than or equal to ₹2 lakhs).
• Bid Price: Enter the price in which you would like to bid, which must be within the price band. You also have the option of using the cut-off price, in which case, you are agreeing to pay whatever the final price is determined to be.
• Number of Lots: Enter the total number of lots, which you would like to apply for.
• UPI ID: Enter your UPI ID in a careful manner.

Step 4: Submit the Application and UPI Mandate

• After you submit the form on your broker’s website, you will receive a “Block Funds” request on your UPI app.
• You need to approve this request to block the amount used to apply for the program in your bank account. The money is not withdrawn yet, it has only been blocked.
• If you do not approve this mandate, your application will be rejected.

Step 5: Allotment and Refund

• Following the IPO closure, the allotment process takes place. If you received an allotment, your blocked amount will be deducted from your account, and the shares will be credited to your Demat account.
• If you did not receive an allotment, the block on your funds will be released and the available amount will be back in your account.
• If you received allotment for only part of your application (for example, you applied for 2 lots and received 1 lot), the money for the unallocated lot is released.

Step 6: Trading Begins

• After the shares are added to your Demat account (usually a day prior to the listing), you can either sell the shares on the listing day or continue to hold it long-term.

Benefits of Investing in IPO

• Possibility of Large Listing Gains:
  • This is the most appealing benefit. If a company is in demand, the share price can increase on the very first day of trading (listing day) and investors can quickly sell their shares for a large profit.

• Access to Early Growth Story:
  • An IPO allows you to buy a piece of a company that has potential at what is relatively an earlier stage of the company’s growth. If it turns into the next “big” company (like a name tech company), your investment could potentially increase in value substantially over time and build significant wealth.

• Transparency and Public Scrutiny:
  • Prior to going public, a company must prepare and file a prospectus, in great detail, to the market regulator (SEBI). This prospectus states details about the company’s finances, business model, risks and future plans. Such transparency is not available in private companies and will help you make a more informed decision.

• Fair Access and Allotment:
  • IPOs have a quota reserved for small, retail investors participation. Allotment is done electronically and fairly, and if you are a small time investor, gives you an opportunity to buy shares even in very popular issues, where institutional investors are also competing.

• Enhanced Public Exposure and Trust:
  • Publicly traded companies provide additional credibility and brand status for a firm. This can create more business opportunities and stability, which can positively affect the value of your investment over time.

Conclusion

In basic terms, an IPO is when a private company offers shares to the public for the first time so that it can raise money and become publicly traded on a stock exchange. An IPO is important for the company since it helps the company raise funds for its business expansion and allows the average person to invest in the company by buying shares. IPOs can be public in one of two ways: fixed price (the price is set) or book building (the price is based on demand). Generally speaking, for applying, all you need is a Demat account, a bank account, and a UPI ID. When the day comes, all you have to do is easily apply online by either signing in to your bank’s net banking service or via an

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