What is an Initial Public Offering, and how does it work?

As people get more and more comfortable with using smartphones and the internet, they are finding unique ways to earn and grow their money. For example, many millennials these days are trying their hand at online share trading to make some additional income. This is evident from the fact that more than 142 lakh Indians opened their Demat and trading accounts in 2021.

If you, too, have started investing in the stock market or are hoping to do so in the near future, that’s excellent. However, before starting your share trading journey, there are a few things you should be aware of.

As a beginner, you can start by investing in Initial Public Offerings or IPOs of companies. If you’re hearing the term for the first time, don’t worry. Here, we will discuss what is an Initial Public Offering, how an Initial Public Offering works, and how you can invest in an Initial Public Offering. Let’s get started.

What is an IPO?

When a private company decides to go public and issues its equity shares for sale for the first time, it is known as an Initial Public Offering (IPO). An IPO helps the issuing company to raise capital from the general public and other investors by diluting its equity ownership.

When a company issues its IPO, it calls for the investors to subscribe to its shares. An IPO is first sold in the primary market to subscribers and then gets listed on the stock markets for regular trading. That is why an IPO can also be defined as the process by which a private company or corporation becomes public by listing its shares on the stock exchanges.

What are the types of IPOs in India?

There are two types of IPOs in India and are classified as per the method used for the price generation of shares. Listed below are the two IPO types,

Fixed price offering 

As the name suggests, a fixed price IPO is where the issuing company sets a fixed price for the sale of its shares. The investors are told in advance about the price of the IPO shares so they can plan their investments accordingly.

Book building offering

In the case of a book building IPO, the issuing company sets a price band for its shares instead of a fixed price. Investors must bid on a price within this price band to subscribe to the IPO. The final price for the allotment of shares is decided based on the demand among the investors.

How does an IPO work?

Every business requires funding from time to time for debt repayment, capital expenditure, restocking inventory, and various other activities. One of the methods to raise funding is by selling equity shares through an Initial Public Offering (IPO).

The IPO process starts when a private company decides to sell its shares to retail and institutional investors. The company can then announce its IPO through one of two methods – either issue a public statement by itself or take the help of an underwriter. After this, the following IPO process is followed:

• The underwriter evaluates the financial aspects of the company by carefully examining its current assets and liabilities
• Then the underwriter decides on the number of shares, offer prices, and estimated IPO release time. This information is compiled in the IPO document
• The company then files a Draft Red Herring Prospectus (DRHP) with the Securities and Exchange Board of India (SEBI). The DRHP contains all details regarding the company’s financials and the IPO
• After getting a nod from SEBI, the IPO team starts working on the marketing of the IPO. Based on the demand generated from the market, it decides on a final offer price
• The company calls for bids from investors. The investors are allowed to bid for the IPO during a specific time frame
• After receiving the bids, the company allots IPO shares to investors. If the bids exceed the number of shares that are up for sale, they are allotted through a lottery
• The IPO shares are then listed on the stock exchanges on a given date. After the listing of the IPO shares, investors can buy or sell them at prevailing market rates in the secondary market

Should you invest in an IPO?

Every novice investor feels the dilemma of whether they should invest in an IPO or not. However, there is no concrete answer to this question. On the one hand, IPOs present a good opportunity to acquire shares of great companies at low prices. You can also invest in an IPO to make listing gains on its listing date.

On the other hand, some IPOs can fail miserably and take all your money with them. So, you must carefully analyse the risk-reward trade-off before investing in an IPO. Your decision should be backed by thorough analysis and market research.

How to invest in an IPO?

If an IPO seems profitable to you and you want to invest in it, here’s how you can do so:

Step 1: Open a Demat and trading account with a stockbroker or your bank if you don’t have one. Then, link your Demat and trading account with your savings bank account. If you don’t even have a savings account, you can open an Metra Trust Savings Account that offers several other benefits and features.

Step 2: Apply for the IPO using your Demat and trading account. If you want to know how to apply for an IPO, you can download the relevant app on your smartphone and log in using your login ID and password.

Step 3: You will need to place your bid while applying for the IPO. You can select your lot size and bidding amount while doing this. Before placing your bid, ensure you have enough money in your savings bank account.

Step 4: Wait for the allotment of the IPO shares. You will be notified of the IPO allotment through an e-mail and a text message, and they will be automatically transferred to your Demat and trading account.

Step 5: If you’re allotted the IPO shares, you can sell them anytime after their listing on the stock market.

To sum it up

IPOs offer an excellent opportunity to earn handsome returns. However, you must be very careful and diligent while subscribing to an IPO. Make sure you have a clear understanding of the issuing company’s fundamentals and growth prospects.

If you want to open a separate saving account for stock trading, why not apply for an Metra Trust Savings Account? This saving account comes with a host of benefits, such as higher interest rates, monthly interest credit, and unlimited ATM withdrawals.

Disclaimer

The contents of this article/infographic/picture/video are meant solely for information purposes. The contents are generic in nature and for informational purposes only. It is not a substitute for specific advice in your own circumstances. The information is subject to updation, completion, revision, verification and amendment and the same may change materially. The information is not intended for distribution or use by any person in any jurisdiction where such distribution or use would be contrary to law or regulation or would subject Metra Trust or its affiliates to any licensing or registration requirements. Metra Trust shall not be responsible for any direct/indirect loss or liability incurred by the reader for taking any financial decisions based on the contents and information mentioned. Please consult your financial advisor before making any financial decision.