What is an IPO?
An initial public offering (IPO) is the first time a company issues shares to the public. This is when a private company decides to go ‘public’.
In other words, a company that was privately-owned until then becomes a publicly-traded company.
Before the IPO, a company has very few shareholders. This includes the founders, angel investors and venture capitalists. But during an IPO, the company opens its shares for sale to the public. As an investor, you can buy shares directly from the company and become a shareholder.
How are shares allocated in an IPO?
There are different investor categories when it comes to IPOs. This includes:
Qualified Insititutional Buyers (QIBs)
Non Institutional Investors (NIIs)
Retail Individual Investors (RIIs)
The allocation of shares differs for all the above groups in an IPO. As an individual investor, you come under the last category.
As an individual investor, you are allowed to invest in small lots worth Rs 10,000-15,000. You can apply for a maximum of Rs 2 lakh in an IPO. The total demand for shares in the retail category is judged by the number of applications received. If the demand is less than or equal to the number of shares in the retail category, you are offered a full allotment of shares.
When the demand is greater than the allocation, it is known as oversubscription. Many times an IPO can be over-subscribed five times over. This means that the demand for shares exceeds the supply by five times!
In such cases, the shares in retail category are offered to investors on the basis of a lottery. This is a computerised process that ensures impartial allocation of shares to investors.
Why does a company go public?
To raise capital for growth and expansion
Every company needs money to increase its operations, create new products or pay off existing debts. Going public is a great way to gain this much-needed capital for a company.
Allowing owners and early investors to sell their stake to make money
It is also seen as an exit strategy for initial investors and venture capitalists. A company becomes liquid through the sale of stocks in an IPO. Venture capitalists sell their stock in the company at this time to reap returns and exit from the company.
Greater public awareness
IPOs are ‘star-marked’ in the stock market calendar. There is a lot of buzz and publicity around these events. This is a great way for a company to publicise its products and services to a new set of customers in the market.
How can you benefit from an IPO?
This is especially true when reputed companies announce an IPO. You get a chance to buy the company’s shares at a much lower price. This is because once the company’s shares reach the secondary market, the share price may go up sharply.
If the company has a potential to grow, buying shares in an IPO can be benefit you. Strong fundamentals of the company mean that it has a good chance of growing bigger. This can be advantageous to you as well. You stand a chance to earn good returns over the long-term.
When a company gets listed on the stock market, it may be traded at a price that is either higher or lower than the allotment price. When the opening price is higher than the allotment price, it is known as listing gains.
Generally, investors expect an IPO to perform well on listing due to factors such as market demand and positive bias. However, this does not always happen. It is possible for a stock price to drop by the end of the first trading day too.
In reality, listing gains may not actually result in good returns for the investor in the long term. So, if you are a trader interested in quick returns, it may be suitable. But for long term investors, it is important to identify a company that can offer high returns five or even ten years down the line.