Last Updated on Mar 9, 2021 by Aradhana Gotur
Many new investors in India entered stock markets in this pandemic, and they got to see numerous IPOs in the year 2020. They were clueless as to what this is and how it works. This article will explain what is IPO, meaning Initial Public Offering, from a company’s perspective. After reading this article, you will have a fair understanding of why a company decides to get listed on stock exchanges.
The article covers the following topics:
- What is an IPO?
- Difference between IPO and shares
- How does a company apply for an IPO?
- How is the issue price calculated?
- Where does the IPO money go?
- How long does an IPO last?
- Advantages and disadvantages of an IPO
- Most famous IPOs till date
Table of Contents
What is an IPO?
IPO is an acronym for Initial Public Offering, where a company’s shares are offered to the public for investment and trading. In return, the company gets money from the subscribers of the IPO. An investor has to bid in lots (multiple shares) through their demat account and then the allotment process takes place.
A company goes public through the IPO route in 2 situations. First, when they need a huge amount of money for their growth. Second, to provide liquidity to their existing shareholders, who are promoters and founders. The other reasons can be to gain credibility in public, establish a net worth in the market, and have broader visibility in the country.
Difference between IPO and shares
IPO is a mode through which a company’s shares get traded publicly among retail and institutional investors. Shares offer ownership rights to an investor. For instance: Let’s say that a company XYZ has 1 lakh outstanding shares in the market and one of its investors, Mr. P, holds 2,000 shares. This means that Mr. P holds a 2% (2,000/1,00,000) stake in the company. In other words, Mr. P has 2% ownership in XYZ.
How does a company apply for an IPO?
It starts with getting board approval to apply for an IPO, and then the company has to choose an investment bank or merchant bank to assist them in the IPO process. The investment bank helps the company with due diligence and all the necessary regulatory filings that need to be done with the stock exchanges. The investment bank also helps the company draft an application with all the financials and goes to SEBI (Securities and Exchange Board of India), the market regulator. Then, SEBI allows the company to issue what is known as DRHP (Draft Red Herring Prospectus), having all the details of the number of shares issued, price band, and the company’s financial performance in the past. This prospectus part and valuation is also taken care of by the investment bank itself. After this, the IPO comes out for 3-5 days, where investors can place their bids to get the company’s shares.
How is the issue price calculated?
The issue price or the price band is arrived at after in-depth analysis by the underwriter or the investment banker. The factors considered are the amount of capital a company wants to raise and the number of shares going public, the demand for the company’s shares among investors, its financials and valuation, their market share in the industry and awareness among investors, and so on.
Where does the IPO money go?
The company going public gets a significant chunk of the money raised from the IPO and uses it to grow. They can invest it to fund new projects, R&D, working capital or for other purposes mentioned in the prospectus. The founders and promoters get money on selling their shares after the lockup period is over.
How long does an IPO last?
In India, the IPO usually lasts from 3 to 15 days depending on certain factors. First 3 days are reserved for bidding where several investors place their bids. This is followed by the process of rejection of invalid bids, post which allotment of shares takes place. Then, the allotted shares are credited to demat accounts of investors and the company receives the money. This is the entire IPO process in a nutshell.
Advantages and disadvantages of an IPO
Below are some advantages of an IPO:
- Amount size: A company can raise an enormous amount of money through an IPO by going public than what it can get via a loan or from its founders.
- Credibility and publicity: Once a company goes public, it tends to gain credibility in investors’ eyes as auditors and securities market regulators also monitor its actions.
- Stocks for payments: If the company’s shares are being traded publicly, it can use the stocks as a mode of payment to employees and board members in the form of a stock options plan.
There are also some demerits of going public:
- Cost of an IPO: Surely, an IPO brings a lot of money, but it has a cost attached to it in the form of fees paid to the investment bank, lawyer, consultant, and accountant.
- Additional disclosures: Now though the company is public, there are several regulatory norms to be followed. It will have to present its audited financial numbers every quarter to its investors.
- Under subscription: There are chances that investors might not react with enthusiasm in bidding for the company’s IPO. In that case, the IPO will be undersubscribed and the capital raised would be lesser than what it expected.
Most famous IPOs till date
On a global level, when Alibaba Group came out with its IPO on New York Stock Exchange in 2014, it raised $25 bn making it the largest IPO the world has ever seen. Other famous global IPOs were General Motors, Agricultural Bank of China, and more. In India, in terms of the issue size, the largest IPO was Coal India Limited in 2010 with an issue size of Rs 15,475 crores, followed by Reliance Power in 2008.