What Is Initial Public Offering and How Does It Work

Initial Public Offering (IPO) is the process by which a company offers its shares to new investors and enters the markets.

This helps the company in raising cash from the markets by selling those shares. The cash raised by Initial Public Offering (IPO) can be utilized by the company for its business purposes. It can be clearing previous pending debts or expansion of current business.

The investors after buying shares via IPO become part of that company and are partners in profits or losses of that company whatsoever it does.

How To Buy Shares Through Initial Public Offering (IPO)

When a company comes with an IPO, the applications are published in leading business newspapers and magazines.

The application states the minimum numbers of stocks (called as a Lot) for which you can apply and the dates of accepting the applications.

IPOs are usually open for 3 to 5 days. The price range for that IPO (single share) is also given in that application.

The investors interested in subscribing for IPO can submit the application form along with the Cash amount ( Cash, Cheque or Demand Draft) before the closing time for the IPO.

You may apply by visiting a Bank or through an Online Share Trading Account if you have one.

Pricing of Initial Public Offering (IPO)

IPO price on which it is to be offered to the public is determined by two methods. The price of IPO is given in the form of range ; say ₹ 100-120 for one share and Lot size (assume) is 50.

To apply for that you would need to deposit an amount of ₹ 120 X 50 = ₹ 6000. If the final price for IPO is fixed at ₹ 110, amount 50 X 10 = 500 would be refunded back to you while shares worth ₹ 5500 would be allotted to you.

Method of Pricing

Fixed :- The issue price is already fixed at the time of launch of IPO. The investors need to apply at that fixed price only. In this method, the demand for IPO is known only after the IPO has closed.

Book Building :- The issue price is not fixed at the launch. The buyers have to bid for the issue. The demand is known on the basis of bids and accordingly the issue price is determined. This is a price discovery method.

Managing The Initial Public Offering (IPO)

The company appoints some financial institutions as the Book Running Lead Mangers for the IPO.

The Lead Managers do all the IPO processing. They create the offer document, get it approved from the securities regulator and the concerned stock exchanges.

After closing of application dates for IPO, these Issues are to be listed on the stock exchanges. The Lead Managers help in listing of the Issue on the stock exchanges.

Listing of Initial Public Offering

After the allotment process is over, the IPO is listed on a stock exchange.

Listing means the issue starts trading on the exchange like other trading stocks.

It is available to buy for all public on a price at which it is trading in the market and not the price at which it was issued.

Thus, normal share trading starts for that Issue.

The company fundamentals and investor’s interest determine the price of the Issue in the market.

If the IPO is listed at a higher price than the price offered at the launch, the Issue is said to be at Premium.

Suppose the above Issue of price 100 – 120 lists at a price of 150, it is said to be at Premium of ₹ 40 and the IPO subscriber makes a profit of 40 x 50 = ₹ 2000 on listing day.

Similarly, if the listing price is lower than the launch price, it is said to be at Discount.

Advantages of Initial Public Offering

• As the investors buy shares directly from the company via IPO, there are no brokerage or commission charges levied.
• IPO allows you buy the shares of a good company at rather cheap prices. At listing of IPO, the prices may go significantly higher resulting in Listing Gains in short time periods. This is the main reason behind love for IPOs by the investors.
• If you remain invested with the company, you become a partner in profits as a shareholder.

Should You Subscribe For Initial Public Offering ?

Taking a decision to subscribe for an IPO depends upon the company fundamentals, reputation and the track record of the Promoters of the IPO.

If you can’t get these details regarding the IPO, you can look to read various research reports on the IPO by the Credible and leading rating agencies before you subscribe.

Try to gather as much knowledge as possible regarding the company and its businesses. Get to know the reasons for raising the money by floating the IPO by that company.

You should definitely go for an IPO if the company has strong fundamentals and Promoters have a credible track record.

The rating agencies may also have a rating for these IPOs as ‘Above Average’, or ‘Strong Fundamentals’. You can take the help of these reports in making your decisions.

IPOs can offer you substantial returns in a matter of few days only in the form if Listing Gains.

Initial Public Offering (IPO) vs Follow On Public Offering (FPO)

When a company goes public for the first time by selling its shares to the investors, it is called as IPO. It is an unlisted company on the stock exchange and is going to be listed for the first time.

When a company is already listed on the exchange but issues fresh new shares to investors to raise more money, it is called as Follow On Public Offering or FPO.

Both IPO and FPO make Primary Markets.

The stocks or shares already listed on the stock exchange make the Secondary Markets.

Learn More

• How To Buy Stocks

From Primary Markets, you can buy only via IPO or FPO while you can buy anytime from the Secondary Markets.