Initial Public Offering (IPO): From Private to Public

What is an IPO?

An IPO, or Initial Public Offering, is when a private company first offers ownership shares to the general public.

Before an IPO: A company is private, owned by founders, employees, and perhaps some early investors.
During an IPO: The company makes ownership pieces (shares) available for anyone to purchase.
After an IPO: Regular people can buy and sell shares of the company on the stock market through a stock broker like Zerodha.

It's like a restaurant that was previously exclusive to just a few people now opening its doors to everyone. The company receives money from these new public investors, which it can use to grow the business, pay off debts, or develop new products.

For investors, an IPO represents the first opportunity to own part of a company that was previously not available to them. When you buy shares in an IPO, you're becoming a partial owner of that business.

When we talk about an IPO in the share market, we're not just referring to a company's public debut. We're exploring the exciting journey a company takes to open its doors to investors. The share market serves as the bustling marketplace where company stocks change hands, and an IPO marks that pivotal moment when a company first steps onto this stage, inviting investors to become part owners in its future.

Now that we've understood what an IPO is, let's explore some common IPO terms that are helpful to know.

Basic IPO terms explained

Issuer: The company offering its shares to the public for the first time.
Underwriters: These are investment banks or financial institutions that help the company go public. They evaluate the company, help decide the share price, and promote the IPO to investors. If any shares are left unsold, underwriters often agree to buy them to ensure the IPO's success.
Price band: A range of prices within which investors can bid during a book-building IPO. The final price is decided based on demand within this range.
DRHP (Draft Red Herring Prospectus): This is a detailed document the company files with SEBI before the IPO. It explains the company’s business, finances, risks, and why it is raising money.
Oversubscription: This happens when more people want to buy shares than the number of shares being offered. In such cases, shares are usually distributed through a lottery or on a pro-rata basis, depending on the rules.
Undersubscription: When not enough investors apply for the available shares, it's called undersubscription. In some cases, underwriters will buy the remaining shares so the IPO can still move forward.
Flipping: This means selling IPO shares very soon after buying them, usually on the day they are listed, in order to make a quick profit.

With these key terms in mind, let's examine the different approaches companies can take when going public.

Types of IPOs

When a company decides to go public, it can choose between two main methods to set the price of its shares:

1. Book building offering

This is like an auction for shares:

The company sets a price range, known as the price band.
Investors submit bids, stating how many shares they want to buy and at what price within that range.
After reviewing all bids, the company determines a final cut-off price.
Investors who bid at or above this price receive shares, depending on availability.

2. Fixed price offering

This is a more straightforward approach:

The company sets a single, fixed price for each share.
There is no bidding involved.
Investors choose whether or not to buy shares at this set price.
Unlike book-building, this method does not allow investors to influence the share price through bidding.

Having explored the different types of IPOs, let's follow the journey a company takes as it transforms from a private entity to a public one.

The IPO journey

1. Decision to go public

The company evaluates its growth needs, market conditions, and readiness to go public. It hires investment banks or financial institutions (underwriters) to manage the IPO process.

2. Filing documentation

The company prepares a Draft Red Herring Prospectus (DRHP) with the help of legal and financial experts. This document outlines the company's financials, business model, risks, and IPO terms. It is submitted to SEBI for approval.

3. Selecting an exchange

The company chooses one or more stock exchanges for listing its shares, typically the Bombay Stock Exchange (BSE), the National Stock Exchange (NSE), or both.

4. Marketing

The company promotes its IPO through roadshows and presentations to potential investors. These events aim to generate interest and gauge demand for the shares.

5. Bidding process

In book-building IPOs, investors place bids within a specified price range, indicating the number of shares they want and their bid price.

6. Price finalisation

Based on demand during the bidding process, the final share price is determined. This price reflects market interest in the IPO.

7. Allotment of shares

If undersubscribed, underwriters may purchase unsold shares.

If oversubscribed, shares are allocated via lottery, pro-rata allotment, or other methods. Refunds are issued for unallotted bids.

8. Listing on stock exchange

The company's shares are listed on the selected exchange(s), enabling public trading of its stock. Options in India include the National Stock Exchange (NSE), the Bombay Stock Exchange (BSE), or both.

9. Post-listing compliance

As a public entity, the company must adhere to regulatory requirements, including regular financial disclosures and maintaining transparency with investors.

Now that we've walked through the IPO process, you might wonder why companies choose to undertake this complex journey in the first place. Let's explore the motivations behind going public.

Why companies choose to go public

1. Raising capital

The primary reason most companies go public is to raise capital. The funds generated through the sale of shares can be used to finance business growth, invest in new projects, or pay down existing debt.

2. No repayment needed

Unlike loans, the capital raised from issuing shares does not need to be repaid. Investors purchase equity in the company, and if they wish to exit, they can sell their shares on the open market without any financial obligation falling on the company itself.

3. Access to more investors

A public listing exposes the company to a much larger pool of potential investors. This enhanced access makes it easier to raise substantial capital compared to private funding rounds.

4. Increased visibility and credibility

Being traded on a public exchange raises the company’s profile. Public companies often receive more media attention and analyst coverage, which can lead to greater brand recognition, increased trust from customers and partners, and more business opportunities.

5. Shares as financial leverage

Publicly traded shares can be used as collateral for securing loans. This provides the company with additional financing options that do not require leveraging its physical assets or cash flow.

6. Exit for early investors

An IPO allows early supporters such as angel investors and venture capitalists to sell their shares in the public market. This gives them an opportunity to benefit from the company’s growth and gain value from their initial investment.

Conclusion

IPOs represent a significant milestone for companies and offer exciting opportunities for investors. Whether you're looking to invest or just curious about the process, understanding IPOs provides valuable insights into the world of stock markets.

Explore the upcoming IPOs and discover more about these companies. You can apply for all the upcoming IPOs on Kite by Zerodha.