What is IPO in Stock Market? History, Importance, Process, Types, Risk & Rewards

Kumar Vimlesh

May 11, 2023

Table of Contents:

What is an IPO in Stock Market?

History of IPO

Importance of IPO

Process of IPO Launching

Types of IPO

Alternatives of IPO

Investing in IPO

Risk and Rewards While Applying for an IPO

Advantages and Disadvantages of IPO

How to apply for IPO

What is IPO in Stock Market?

IPO stands for Initial Public Offering and IPO in Stock Market is a process by which a private company becomes a public company by offering its shares first time to the general public through one or more stock exchanges. In other words, an IPO is the first-time issuance of shares, that a company sells to the public in order to raise capital.

In an IPO, the company hires investment banks to underwrite and sell the shares to the public. The underwriters help in determining the price and the number of shares to be sold, and they also market the offering to potential investors. The process usually involves a lot of publicity and media attention, as the company aims to generate interest from institutional investors, such as mutual funds, pension funds, and hedge funds, as well as from HNIs & retail investors.

When the shares start trading on a stock exchange, their price is determined by supply and demand. If there is high demand for the shares, the price may rise above the initial offering price, which can result in significant gains for the investors who bought the shares during the IPO. However, there is also the risk that the price may fall below the offering price, resulting in losses for investors.

History of IPO:

The history of IPOs can be traced back to the 1600s, when the Dutch East India Company became the first company to issue shares to the public. The company was formed to trade with Asia and was financed through the sale of shares to investors. The success of the Dutch East India Company’s IPO paved the way for other companies to go public in the following centuries.

In the 1800s and early 1900s, many of the largest companies in the world, such as the East India Company, the London Stock Exchange, and the New York Stock Exchange, were formed and went public through IPOs. During this time, many of the IPOs were designed to raise funds for infrastructure projects, such as railroads and canals.

In the mid-20th century, the popularity of IPOs increased significantly, as many companies went public to finance expansion and growth. The post-World War II era saw the rise of many of the world’s largest companies, including IBM, Coca-Cola, and McDonald’s, which all went public through IPOs.

In the 1990s and early 2000s, the tech boom led to a surge in IPO activity, as many startups sought to go public to raise funds and capitalize on investor enthusiasm. Companies like Amazon, Google, TCS, Infosys and Facebook all went public during this period on different exchanges, with their IPOs generating significant interest and attention from investors.

Importance of IPO:

Access to capital: Going public through an IPO provides companies with access to a significant amount of capital from investors, which can be used to finance growth, invest in new products or services, or pay off debts.
Increased visibility: An IPO can increase a company’s visibility and profile, making it easier to attract new customers, employees, and business partners.
Liquidity: Going public through an IPO provides shareholders with liquidity, as they can sell their shares on the public market.
Benchmarking: An IPO can serve as a benchmark for a company’s performance, as the public market provides a transparent valuation of the company’s shares.
Exit strategy: An IPO can provide an exit strategy for early investors and founders, allowing them to monetize their investments and move on to new ventures.
Prestige: Going public through an IPO can enhance a company’s prestige and reputation, which can attract new customers, employees, and business partners.
Economic growth: IPOs can contribute to economic growth by providing capital to companies that can use it to innovate, create jobs, and drive economic activity.

Process of IPO Launching:

The process for an IPO, or Initial Public Offering, typically involves several stages, which may take several months or even years in few cases to complete. Here are the common steps involved in the IPO launching process-

Preparing for the IPO: The company hires investment bankers, lawyers, accountants, and other professionals to help prepare for the IPO. They will review the company’s financial statements and operations, identify potential risks and issues, and prepare the necessary documentation for regulatory filings.
Conducting Due Diligence: The underwriters, lawyers, and accountants will conduct a comprehensive review of the company’s operations, financials, and other relevant information to ensure that all information provided in the offering documents is accurate and complete.
Filing the Registration Statement: The company files a registration statement with the Securities and Exchange Commission (SEC) to disclose information about the offering, the company’s operations, financial statements, and risks associated with investing in the company.
SEC Review: The SEC reviews the registration statement to ensure that all information is accurate and complete, and may provide comments or requests for additional information.
Roadshow: The company and underwriters conduct a roadshow to market the IPO to potential investors. This typically involves meetings with institutional investors, such as mutual funds, pension funds, and hedge funds, as well as individual investors.
Pricing the IPO: Based on investor demand and market conditions, the underwriters determine the offering price and number of shares to be sold.
Offering Day: On the day of the IPO, the shares are sold to investors at the offering price. The shares start trading on a stock exchange, such as the New York Stock Exchange, NASDAQ, NSE & BSE etc.
Post-IPO: After the IPO, the company must comply with various regulatory requirements, including filing regular financial statements and disclosures with the SEC. The company’s shares will continue to trade on the stock exchange, and their price will fluctuate based on supply and demand.

Types of IPO:

Fixed Price IPO: In a fixed price IPO, the company and underwriters determine a fixed price for the shares to be sold to investors. All investors who are eligible to participate in the IPO can purchase shares at the same price.
Book Building IPO: In a book building IPO, the company and underwriters determine a price range for the shares, and investors can bid for shares within that range. The final price is typically set at the upper end of the range, based on demand from investors.
Dutch Auction IPO: In a Dutch auction IPO, the company sets a price range and investors submit bids for the number of shares they want to buy at a specific price. The underwriters then determine the clearing price based on the number of shares that can be sold at that price.
Green Shoe Option IPO: In a Green Shoe Option IPO, the underwriters have an option to purchase additional shares from the company to stabilize the stock price if demand is higher than expected.
Online IPO: In an online IPO, the shares are sold directly to investors through an online platform, without the need for intermediaries like investment banks. This type of IPO is relatively new and has become more popular in recent years.
Direct Listing: In a direct listing, the company does not issue new shares, but existing shareholders sell their shares directly to the public. This can be a cost-effective alternative to a traditional IPO, but is typically only used by companies that are already well-known and have an established following.

What are the Alternatives of IPO for companies?

IPO is an attractive option for companies those seeking to raise capital and increase visibility. But this is not the only option available to raise capital for the companies. If a company choose to try out some different method to raise capital and achieve liquidity, they may try followings alternative ways:

Private placements: Private placements involve selling shares to a select group of investors, such as venture capitalists, private equity firms, or institutional investors. Private placements can be less expensive than an IPO and provide greater control over the offering process.
Direct listings: Direct listings allow companies to go public without raising capital through a traditional IPO. Instead, existing shareholders sell their shares directly to the public, bypassing the traditional underwriting process.
Special purpose acquisition companies (SPACs): SPACs are shell companies that raise capital through an IPO and then use the proceeds to acquire an existing company, effectively taking it public. SPACs can provide a faster and less expensive path to going public than a traditional IPO.
Crowdfunding: Crowdfunding platforms allow companies to raise capital from a large number of individual investors. Crowdfunding can be a cost-effective way to raise capital and can also provide valuable marketing and customer engagement opportunities.
Private equity: Private equity firms can provide capital to companies in exchange for an ownership stake. Private equity can provide access to capital, operational expertise, and strategic guidance, but it can also involve giving up a significant amount of control over the company.

Investing in an IPO:

Investing in an IPO can be an attractive opportunity for investors seeking to participate in the growth of a new and innovative company. However, it’s important to approach IPO investing with caution and to do your research before investing. Here are some key factors to consider:

Company fundamentals: Before investing in an IPO, it’s important to understand the company’s business model, industry, competition, financials, and growth potential. You should also research the company’s management team and their track record.
Valuation: The price of an IPO can be influenced by many factors, including market conditions, investor sentiment, and the company’s financial performance. It’s important to evaluate the valuation of the IPO and compare it to other companies in the industry.
Risks: Investing in an IPO can be risky, as the company may face challenges such as competition, regulatory issues, or a lack of profitability. It’s important to evaluate the risks associated with the IPO and consider your risk tolerance before investing.
Underwriters: The underwriters of the IPO, typically investment banks, play an important role in the offering process. It’s important to research the underwriters and their track record with previous IPOs.
Allocation process: The allocation process for IPO shares can be complex and competitive, with limited shares available for individual investors. It’s important to understand the allocation process and the likelihood of receiving an allocation of shares.
Lock-up period: After an IPO, insiders and early investors may be subject to a lock-up period, during which they are prohibited from selling their shares. It’s important to understand the lock-up period and how it may impact the stock price.

What are The Risk and Rewards While Applying for an IPO?

IPOs can offer both risks and rewards for investors who participate in the application process. Here are some key factors to consider while taking a call to apply for an IPO:

Risks:

Market volatility: IPOs can be affected by market conditions, and the price of the shares may fluctuate significantly in the days and weeks following the IPO.
Limited information: Unlike established companies that have a track record of financial performance, IPOs may have limited financial information available, which can make it difficult to assess their long-term potential.
Regulatory risks: IPOs are subject to regulatory scrutiny, and the company may face legal or regulatory challenges that could impact their future growth prospects.

Rewards:

Potential for high returns: IPOs can offer the potential for significant returns if the company performs well and the share price increases.
Opportunity to invest in new and innovative companies: IPOs often involve companies that are new to the market, with innovative business models or disruptive technologies that have the potential for strong growth.
Allocation of shares: If you are allocated shares in an IPO, you may be able to purchase them at a discount to the market price, which can provide a lower entry point and potentially higher returns.

Advantages and Disadvantages of IPO:

Advantages-

Capital raising: An IPO provides a way for a company to raise significant amounts of capital by selling shares to the public, which can be used to fund business operations, pay off debt, or invest in new projects.
Increased visibility: Going public through an IPO can increase a company’s visibility and brand recognition, which can help attract customers, employees, and investors.
Access to liquidity: Once a company goes public, its shares can be traded on the stock exchange, providing investors with a liquid market for buying and selling shares.
Employee incentives: An IPO can provide a way for a company to offer stock options or other equity incentives to employees, which can be used as a way to attract and retain talent.
Valuation: An IPO can provide a way to establish a market valuation for the company, which can be helpful for future fundraising or acquisition negotiations.

Disadvantages-

Costly affair: The IPO process can be costly, as companies must pay fees to investment banks, legal and accounting firms, and stock exchanges.

2. Regulatory requirements: Companies that go public are subject to strict regulatory requirements, including financial reporting, disclosure, and corporate governance rules.

3. Shareholder pressure: Once a company goes public, it is accountable to its shareholders, who may put pressure on the company to deliver strong financial results and growth.

4. Loss of control: Founders and management may face pressure to cede control of the company to outside investors who may have different goals and priorities.

5. Market volatility: Once a company goes public, its stock price can be affected by a variety of factors, including market conditions, investor sentiment, and company performance, which can lead to significant price fluctuations.

How to apply for an IPO?

To apply for an IPO, you need to follow these general steps:

Open a Demat account: The first step is to open a Demat account (Not require if you already have) with a Depository Participant (DP). This account will hold the shares you purchase in electronic form.
Check eligibility: Before applying for an IPO, you need to check if you are eligible to participate. Some IPOs may have restrictions on who can participate, such as a minimum investment amount or a limit on the number of shares that can be purchased.
Apply for the IPO: You can apply for the IPO online through your broker’s website or through the website of the stock exchange where the IPO is listed. You will need to provide your Demat account details, PAN number, and other relevant information.
Make payment: You can make payment for the IPO using net banking, UPI, or other online payment methods. Some IPOs may also accept payment through cheques or demand drafts.
Check allotment status: Once the IPO closes, the shares will be allotted to investors. You can check the allotment status online using your PAN number or application number.
Receive shares: If you are allotted shares, they will be credited to your Demat account within a few days of the allotment date. You can then sell or hold the shares as per your investment strategy.

Summary: Today, IPOs continue to play a significant role in the global economy, with many of the world’s largest and most innovative companies choosing to go public to raise capital and increase their visibility. While the IPO market can be subject to volatility and fluctuations, but still, it remains an important source of funding for companies looking to grow, debt repayment and expand.

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