What Is Initial Public Offerings: All You Need to Know

Companies often turn to the public markets when they require funds to expand their operations. One of the most popular ways to execute this plan is through an IPO (Initial Public Offering). In this blog, you will get a detailed explanation of what are IPOs. Additionally, we have discussed its various types alongside the different benefits and disadvantages of investing in an IPO.

What Are Initial Public Offerings?

An Initial Public Offering denotes the process where private organisations list their company shares in the market. These offerings are made to the general public to help raise equity capital from a pool of investors. The whole procedure converts a privately owned company into a public company. 

IPO listings are a great opportunity for retail investors to gain a lucrative return on their investments. However, this particular investment strategy calls for highly informed decision-making. Therefore, budding investors need to understand the basics before investing in IPOs. 

What Is an IPO in the Share Market? 

In the stock market, a private corporate body or company can turn into public by selling a part of its stake as an IPO to retail investors. 

The primary purpose of launching an IPO is to infuse fresh equity capital into the company. It enables seamless trading of the existing assets and monitises the investments already made by the early investors. 

Through the prospectus, institutional investors, the general public and even high-net-worth individuals (HNIs) can verify the information regarding the first sale of shares. This prospectus is a detailed document that enlists all the proposed offerings of the firm. 

Once the IPOs are done, traders can freely access the respective company’s share in the open market. Stock exchanges mandate a minimum free float for shares, defined by both a fixed value and a proportional requirement of total share capital.

Types of IPO

Commonly, there are 2 primary types of IPOs:

1. Fixed Price Offering

Company stakeholders, when implementing a fixed price issue, adopt a straightforward approach to fix the share price before they are available in the open market. 

In this method, the company decides a fixed value per share which does not fluctuate throughout the IPO process. Before arriving at this price, the stakeholders hold meetings with financial experts such as underwriters and merchant bankers. 

1. Book Building Offering

Compared to fixed price issues, book building is relatively more dynamic in deciding share prices. When a company chooses this method, it sets a price bracket or band within which retail investors need to bid for shares. The lower limit of this range is referred to as the 'floor price' whereas the upper limit is known as the 'cap price'. 

When the bidding goes on, investors make bids within the quoted range. This system allows the company to judge market investor sentiments and thereby finalise the share’s price depending on the demand generated. 

In India, book-building issues are steadily increasing these days due to their effectiveness in reflecting market demand. Additionally, it empowers all investors to indirectly control the share price by showing their willingness to pay, thus effectively keeping pricing in line with market demand.

IPO Advantages

People willing to invest in IPOs are usually familiar with these benefits:

• Access to a Growing Company

When companies get a new stream of cash flow with an IPO, it typically creates more value for the investors. Moreover, after going public, companies tend to adopt higher prospects and execute ambitious growth plans. 

Initial Public Offerings provide opportunities for investors to become early shareholders and capitalise on a company's future expansion. Historically, most successful IPOs have earned significant returns for the early investors which makes them an attractive investment option. 

• Opportunity to Invest in Innovative Companies

IPOs allow investors to hold stakes in innovative companies that are likely to implement technological advancements in their respective sectors. Putting your money in these companies allows you to grow with the reshaping industry. Thus, people tend to search for such companies after they have a vivid idea about what is IPO and how it works. It enables investors to capitalise on rising trends and industrial shifts. 

• Portfolio Diversification

Portfolio diversification is a vital risk management strategy favoured by most people who invest in the secondary market. IPOs cater to this purpose as investors get the chance to lower their risk concentration by investing in new companies which also elevates their return potential. 

• Early Entry Discount

Investors can take entry into a company through an IPO at a pretty early stage. It enables them to own company shares at a much lower rate compared to the post-IPO market price. This automatically generates a potential for substantial returns in the long run. 

Disadvantages of Investing in IPO

A few factors must be taken into account before one invests in IPOs:

• More Costs

IPOs are generally costly. Besides the consistent regulatory compliance costs for public companies, the transaction procedure in an IPO requires investment in an underwriter, an advertiser and finally an investment bank to make sure that everything runs seamlessly. 

• Extra Pressure

Amidst market turbulence, publicly traded companies remain under substantial pressure to maintain high stock values. Executives may therefore not make drastic decisions required to improve operations, as those can potentially influence the stock price.

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How to Invest in an IPO?

Now that you are totally aware of what are IPOs, you can start investing by following these steps:

Step 1: Open a Demat Account

Every IPO investor should have a demat account that will be used to hold the acquired units electronically.

Step 2: Research the IPO

A person should research the IPO-allotting company in detail and also gain knowledge of its financial health to assess risk-to-reward possibilities.

Step 3: Apply for the IPO

Applicants can use the ASBA (Application Supported by Blocked Amount) route or utilise their respective banking platforms to bid for IPOs. Moreover, you can select any trusted online trading platform or stockbroker to apply for IPOs. When applying, you must specify the volume of shares you want to apply for and consequently pay for the same.

Step 4: Wait for Allotment

When the IPO allotment is withdrawn, the company starts allotting shares according to the demand. In some cases, when the IPO becomes oversubscribed you can get fewer shares than what you originally applied for. 

Step 5: Listing Day

If shares are allotted to your demat account, you can see them on your platform. Once the company is listed, you can trade the allotted units on the stock exchange. 

Final Word

For companies, IPOs are a great method to raise capital whereas for investors they form a big opportunity to realise potential growth. 

Even if you have understood what are IPOs and how they work, still fixed deposits may seem appealing to you given their simplicity and convenience. If that is the case, consider checking out the fixed deposit interest rates of top RBI-approved FD providers on the Stable Money website. With us, you can start earning up to 9.10% interest per year all from the comfort of your home.