IPO Investment Guide For Beginners: Full Form, Definition and Process

In 2023, more than 15 Initial Public Offerings were announced. A record capital of Rs 25,000 crore was raised through IPO investments. With so much money being raised from IPO’s, you might be wondering, “What exactly is an IPO investment and how does it work?” So, let us begin by understanding:

1. What is the full form of IPO and its Definition?
2. Why do companies raise IPOs?
3. What is the process of issuing IPOs?
4. How can you benefit from an IPO?
5. Things To Do Before Investing in an IPO
6. Points to Remember Before Investing in an IPO
7. Advantages of an IPO
8. Disadvantages of an IPO
9. Important terms used in IPO Investment
10. Performance of IPO issues in 2020
11. FAQs

IPO stands for ‘Initial Public Offering’.  In an IPO investment, the company issues shares to the general public for the first time.  IPO Full Form and Definition.

Here's a video which will explain the concept in a simple way.

With an IPO investment: 

• The company raising funds can be a new or an old company. 
• The company gets its shares listed on the stock exchange for the first time. 

Why do companies issue IPOs?

Let's say, Mr Joey owns ‘Joey’s Pizza’ across Mumbai, Pune and Hyderabad. In the last 10 years, Joey’s Pizza has become a strong pizza brand.  Now, Mr Joey wants to expand his business and launch Joey’s Pizza in all metro cities in India. But, he does not have enough capital to grow his business. So, how will Mr Joe expand his business?

1. He thinks of taking a bank loan but interest rates are too high.
2. He plans to add his friend Tony as a partner of Joey’s Pizza, but he does not have a huge capital to invest.

Finally, he plans to raise money by issuing shares of Joey’s Pizza through an IPO investment.  The investors who believe in Joey’s Pizza will invest in the IPO and become a shareholder of the company.   With the money raised through the IPO,  Mr Joey will expand his business in all metro cities of India!

So, with the above example we can easily understand that companies issue IPO for the following reasons:

1. The main purpose of an IPO is to raise money. Companies who wish to expand their business, repay loans, etc. raise funds by selling a portion of its equity stake to the investors. 2. Through IPO investments, the shares of the company get listed on the stock exchange and this increases the liquidity of stocks. 3. By a company going public, the credibility and brand value of the company increases. The name of the company being flashed on the stock exchanges is a matter of pride for the company. The above-mentioned are the reasons why a company floats an initial public offering.

Process of issuing an IPO 

After you understand why a company issues IPO, the next question that comes to mind is: “How is an IPO issued?” Let's take a look at the step by step process of issuing shares in an IPO.

Step 1: Selecting an investment bank

In order to issue IPO investment to the general public, the first step is to select an investment bank who will act as an underwriter.  Who is an underwriter? An underwriter is an investment bank who would help the company to establish various details such as,

• How much money the company hopes to raise
• What will be the initial price per share

In case of a large IPO, there can be multiple investment banks involved and they act as facilitators in the IPO investment process.

Step 2: Creating the Red Herring prospectus

The next step of the IPO investment process is to create the ‘Red Herring Prospectus’.  What is a Red Herring Prospectus? The term "red herring" is derived from the bold disclaimer in red on the cover page of the prospectus. Red herring prospectus is used to attract potential institutional investors to invest in the company.  The prospectus includes various segments such as financial records, future plans for the company, potential risks in the market, expected share price range, etc.

Step 3: SEBI approval

The Red Herring prospectus is then submitted to the Securities and Exchange Board of India (SEBI). SEBI then goes through the details of the statement and if the information is found correct, it allots a date to the company to announce its IPO investment to the public.

Step 4: Stock exchange approval

The listing of shares is the process where securities are allowed to deal on a recognised stock exchange. But for that, the company needs to be approved by the exchange. For instance, the Bombay Stock Exchange (BSE) has a listing department whose purpose is to grant approval for IPOs.   For example: -     The minimum issue size should be Rs 10 crore. -     The minimum market capitalization of the company should be Rs 25 crore. -     The minimum post issue paid-up capital of the company should be Rs 10 crore.

Step 5: Subscription of shares

Once all the formalities are done, the company makes the shares available to investors through IPO investment and this is done on the dates specified in the prospectus. The investors who wish to apply for the IPO investment will have to fill out and submit the IPO application form.

Step 6: Listing of IPO

The shares are allotted to different investors on the basis of demand and price quoted in their IPO application forms. Once the allotment is done investors get the shares credited to their demat account. However, In the case of oversubscription i.e., if the demand for shares is higher than the number of shares raised by the company, the investors may not get the number of shares they originally wanted.  Some investors may not even get any shares and the amount of the shares is not debited from their bank account.

How can you benefit from an IPO Investment?

Let's look at a few benefits of IPO investment through which you can maximise profits. 1. First-mover advantage This strategy is true when reputed companies announce an IPO.  You get a chance to buy the company’s shares at a much lower price during an IPO investment. This is because once the company’s shares are traded in the secondary market, the share price might go up and vice versa. 2. High returns If the company has strong fundamentals, then an  IPO investment can benefit you to a great extent.  Strong fundamental companies have huge possibilities to grow and you can earn good returns over the long-term. 3. Listing gains What are listing gains? Once a company gets listed on the stock exchange, if the opening price is higher than the allotment price, it is known as listing gains. Generally, investors expect an IPO investment to perform well on listing, due to factors such as market demand.  However, this does not always happen. For long term investors, it is important to identify a company that can offer high returns in five or even ten years down the line. Don’t forget to read this article on how to apply to an IPO investment online through Samco using UPI Investing in IPOs can be a smart move if you are an informed investor. But not every upcoming IPO is a great opportunity.  The advantages and disadvantages of an IPO goes hand-in-hand.

Advantages of IPO

• The company can get cheaper access to capital.
• Increase in the prestige and public image of the company due to high exposure from the stock exchange.
• The listed stock helps to attract better management and employees.
• The company keeps increasing and diversifying the equity base.
• Creating multiple financing opportunities for the company through Equity, Cheaper bank loans, Convertible debt, etc.

Disadvantages of an IPO

• A significant cost to be incurred on marketing and legal, etc.
• Disclosure of discreet financial and business information which can be useful for competitors, suppliers and customers.
• A lot of time, effort and attention needs to be given to the management of the company.

Things you should consider before investing in an IPO

IPO investments are not always successful, some might open below issue price! Some reputed brands also had failed IPOs like Cafe Coffee Day, Adlabs, ICICI Prudential, Reliance Power, etc. So, it is very essential to know the basic things before you invest in an IPO.

1. The company coming up with an IPO investment does provide a prospectus. You must carefully scrutinise and read all the details provided in it before arriving at any decision about IPO investment.

2. In the Red Herring Prospectus a higher percentage of shares held by institutional investors and banks could be a positive sign, indicating their confidence in the company. The prospectus is uploaded on SEBI’s website.

3. While applying for an IPO investment, you must be aware of the fact that the company is not liable to reimburse the capital to the investors.

4. Another key factor to look at is the entity which is promoting the IPO. The key promoters could either be a company or an individual, as recognized names add a certain credibility to the IPO issue and therefore, add a premium to the price as well.

5. Legendary investor, Warren Buffett, always propagates: “Invest in the business you understand.” This is because a thorough understanding of a business can help you make better decisions, so do your homework well!

Important terms used in IPO Investment.

1. Offer Document: This document gives all basic information like the promoters of the company, the financial condition, objectives of the initial public offering, etc.

2. Price Band: The price range within which the investors can bid in an IPO is called the price band. 

3. Bid lot: The minimum quantity that an investor needs to bid for is applicable in bid lot multiples only.

4. Issue Size: The number of shares opened up for overall bidding

5. Cut-off price: The price at which the shares will be offered to investors is called the cut-off price.

Performance of IPO issues in 2020

Final Thoughts

In the article we have learnt everything about IPO investment, its advantages, disadvantages and most importantly the things you should consider before investing in an IPO. Investing in newly launched public companies can be extremely rewarding. However, you must also know that it can be risky and profits are not guaranteed. Having said that, over the years, Initial Public Offerings have offered good returns to investors. You may consider investing in it after researching about the company, its management, etc.  Every month a lot of IPOs get listed on the stock exchange, all you have to do is find the companies with higher potential and invest in them through your Demat account. 

FAQs

1. Who is eligible to apply for an IPO?

Any adult who is competent to enter into a legal contract (18+) can apply for IPOs. It is necessary to have a demat account for investing in IPOs because nowadays all allotments are done only in dematerialised form only.

2. In an IPO investment, how do I know which price to apply?

There are 2 prices you need to understand here.  You need to bid at a price that is within the range. All bids that are below the price range will be rejected. 

Example: Suppose the range is Rs. 530 to Rs 560. If you have bid at Rs. 550 and the final discovered price is Rs. 560 then your bid will be rejected. The convenient option is to just bid at cut-off where you accept to take the IPO at whatever price is finally discovered.

3. For how many days is the IPO kept open?

The company will keep the IPO open for a period of 3-4 days. 

4. What is the process after the IPO is closed?

The normal process is to finalise on the basis of allotment and then allot the shares within a span of 10-12 days. Post which the company is listed on the stock exchanges. There is a popular ceremony called the “Ringing the Bell” ceremony which is done by the promoter of the company to declare that the company is available for trading on the secondary markets.

5. Are my funds locked once I apply for the shares?

That is where ASBA (Applications Supported by Blocked Amounts) comes in handy for retail investors.  The amount is only blocked in your designated bank account and you continue to earn interest. On the date of allotment, the account is debited only to the extent of the shares allotted to you and the block is debited from your bank account.