What is an IPO: IPO Definition & How It Works? | Espresso

Know Everything About How Does an IPO Works?

Initial Public Offering, also known as IPO, is the first time when a private company offers shares to the public. In this process, the ownership gets transferred- from being entirely privately held, the ownership of the company is given to the public.

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One of the major reasons for companies going public is that not all companies are able to raise enough money from private investors, and offering shares to the public has other advantages than the fulfilment of capital needs.

For you as an investor, IPOs can prove to be very profitable, provided you choose the right ones. You would not want to miss this great opportunity that comes knocking only a few times. If you pick the right IPO, the returns on investment can be rewarding.

If you want to know the IPO definition, how does an IPO work, and IPO importance, you will get all these in the upcoming paragraphs.

IPO Definition

As you know, IPO is the first time any privately held company offers shares to the public. Let us get into some basics of an IPO:

  • IPO means when a company offers its shares to the public in exchange for capital.
  • The IPO process is regulated by SEBI( Securities and Exchange Board of India).
  • If you wish to buy shares in an IPO, you have to cast a bid for the shares that you want. If the bid that you have raised is accepted, you will be allotted the shares.
  • If you do not get the shares due to over-subscription, the money will be refunded to you.
  • If you take part in the IPO and purchase the shares, then you become a shareholder of that company.
  • When you become a shareholder, you can make gains by selling the shares on the stock exchange, or you can get dividends on the number of shares that you hold in that particular company.
  • If a company wishes to file an application for IPO, it must adhere to all the strict rules and regulations in order to get approval from SEBI.
  • IPO is open to every retail investor, and anyone can apply for the same through their stockbroker.

IPO Importance for Companies

Here is why IPO has importance for companies:

  • The major IPO importance for companies is the availability of huge capital. There can be no money like the money that you get from the public.
  • When a company gets listed on the stock exchange, it becomes more credible. The company is deemed to be accountable to the hundreds or thousands of investors who are shareholders of the company. This makes the company to be perceived as being more responsible.
  • An IPO also assists the company in gauging the sentiments of the public towards the company. Also, this gives an easy exit to the private investors who can sell off their shares at high profits or can see their net worth skyrocket as the shares start to rise in value.
  • This also provides leverage to the companies when they negotiate the terms of their loans, the interest rate on their loans, or during mergers as well as acquisitions. In addition, with the help of loans, companies can receive capital at low costs because the interest rate will be lower.

How Does an IPO Work?

Here is a step-by-step answer to how does an IPO work:

  • First, a private company makes the decision to raise money through an IPO.
  • The company then gets in touch with an underwriter, which is usually a consortium of some investment banks that make a decision on the price band or the price of shares, the number of shares that the company should offer, etc.
  • The underwriter contracted by the company then begins to draft an application to be sent for SEBI’s approval that includes the past financials of the company, including the debts or liabilities, profits, net worth, and assets. The application should also mention the ways the funds that will be raised will come into use.
  • SEBI carefully scrutinizes and examines the application that is sent by the company and, after making sure that all the rules and regulations have been adhered to and fulfilled, allows the company for the issuance of a red herring prospectus.
  • The document that the company releases mentioned the number of shares being offered in the IPO, and the price of each share is known as the red herring prospectus. The prospectus also includes the details of the past performance of the company.
  • In the Road Show, executives go around and meet potential investors and woo them to invest in the shares of the company.
  • The IPO then opens, and usually, it ranges from 3 to 21 days. But mostly, it stays open for 5 days.
  • At this time, all the retail investors can bid for the shares of the company through their stockbrokers online or via their banks.
  • To be able to participate in an IPO, you must have a Demat account and a PAN card.
  • If the stocks that you bid for are allotted to you, they are credited to your Demat account. If they are not allotted, you get a refund.

Thus, this is how an IPO works.

Conclusion

This is all you need to know about how the IPO works and the IPO’s importance for companies. IPOs can be rewarding for you as an investor if you choose the company after careful consideration. So, do your research and then apply for an IPO.

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Frequently Asked Questions

  • Oversubscription: This refers to the condition in which the number of shares that the investors have applied for is more than the number of shares that are offered.
  • Under subscription: This refers to the condition in which the number of shares that the investors have applied for is less than the number of shares that are offered.

Here are the eligibility criteria for applying for an IPO:

  • You must have a valid PAN card.
  • You must have a Demat Account.
  • Having a trading account is not essential, but if you wish to sell off your stocks on the listings, then you need a trading account.