What Is an IPO in the Stock Market? How It Works in India

What is an IPO? An initial public offering (IPO) is a way for a company to raise money by selling part of the company to the public for the first time. The company will also list the company’s shares on a stock exchange, so that investors can then buy or sell the shares on the stock exchange. An IPO also offers Indian investors the opportunity to study companies and their shares before they start trading on the stock exchange. However, an IPO does not always mean a share is undervalued, and applying for a share does not mean that share will be purchased.

Exploring an IPO? Before applying, understand the issue structure, eligibility, application process and risks. You can review IPO information and investor resources as part of your research.

This beginner's guide explains the meaning of an IPO, the reasons why a company would go public, how the public issue process works in India, how applications and allotment work, what listing means, and the important parts of the offer document. This guide explains the difference between a fresh issue and an offer for sale (OFS) and why listing gains are uncertain.

What Is an IPO in the Stock Market?

An Initial Public Offering (IPO) is when a company makes shares available to the public for the first time. Prior to an IPO, shares may be held by founders, employees, investors (i.e. private or institutional investors), and others. A public offer is made via a process called a public issue.

Upon completion of the process, if shares are listed on a recognized stock exchange, members of the public are allowed to trade shares on the exchange, in accordance with the rules. Transactions on the stock exchange are tertiary market transactions. Transactions on the stock exchange during the offer period are primary market transactions.

There are applicable securities laws, regulations and exchange requirements in India, governing public issues. The Securities and Exchange Board of India (SEBI) is the regulator for the securities market and the relevant framework for public issues. Merchant bankers, underwriters, registrars, stock exchanges, depositories, banks, and other intermediaries are involved in the process.

An IPO, however, does not guarantee that the shares will list at a higher price, or that the company will not face risks after listing. The price at which shares will be offered to the public is determined in the offer process. Other factors, like the state of the stock market and the economy, will determine the stock price.

Why Do Companies Launch an IPO?

There are multiple reasons why a company may decide to go public. While the reasoning can be found in the offer document or communicated by the company, there are a number of presumptions that can be made depending on the nature of the IPO.

Raise capital for the business

A public listing may allow a company to raise capital for multiple reasons, such as growth, expansion or other activities. The proceeds of the offer may also be used for funding capital expenditure. The offer document should specify the purpose of the funding as well as the attendant risks and uncertainties.

Provide an exit opportunity to existing shareholders

A public offering may also allow existing shareholders the opportunity to sell their holdings. An Offer for Sale (OFS) provides existing shareholders the opportunity to sell their shares to the public, and the proceeds go to the shareholders selling their shares rather than the company.

Fresh Issue vs Offer for Sale (OFS)

One of the most important IPO distinctions is whether the issue consists of newly issued shares, shares sold by existing shareholders, or a combination of both.

A fresh issue may dilute existing shareholders because new shares are created. Dilution is not automatically negative: if the capital is used productively, the company may benefit. Investors should examine the issue's purpose, expected returns on planned investment and the effect on shareholding.

An OFS does not directly add capital to the company's balance sheet. It can, however, change the ownership distribution and provide liquidity to selling shareholders. A large OFS should prompt investors to understand who is selling, how much they are selling and what the offer document says about their reasons. Some IPOs combine both, so the headline issue size alone does not tell investors how much new capital the company will receive. Our explainer on OFS in an IPO covers this in more detail.

How Does an IPO Work in India?

This information is based on how a typical IPO process works in India and how various Intermediaries are involved at each step of the process.

1. The company prepares for a public issue

The issuer and the relevant intermediaries (e.g. merchant bankers, lawyers, auditors and others) prepare the disclosures and complete the due diligence and the applicable legal and regulatory processes. Based on the requirements of the securities laws, the offer document contains a description of the issuer’s business and financial condition, material business and financial risks, structure of the issue, proposals of promoters and selling shareholders, and the use of the proceeds.

2. Offer documents are filed and reviewed

The public issue documents are filed with the relevant authorities, and are made available to the public through prescribed channels. Based on the applicable process, the documents may include a draft offer document and a final offer document (also referred to as a prospectus). Investors are advised to review the latest documents (including supplements) rather than relying on the promoter’s summaries or other informal commentaries.

3. The company announces issue details

The issuer announces important terms of the issue, which may include the opening and closing dates of the offer, price band, the offer price, minimum bid lot, issue type and the categories of investors. These terms are subject to change based on the applicable process. Investors should check these against the latest offer documents, notices of the exchange or the issuer.

4. Investors submit applications

Investors must apply through approved routes like endorsed broker platforms or approved application processes. All applications must comply with the terms of the offer, limitations (if any) for the category, payment/blocking arrangements and cut-off times. A proper application does not guarantee an allotment.

5. The issue closes and allotment is finalised

Applications are processed based on the allocation rules and in case of oversubscription, not all applications for a category will be allotted (especially if the category is subscribed to a greater extent). The allotment in such cases may be proportionate, or prescribed draw/ lottery may be applicable, based on the rules of the issue. Investors should look at the official basis of allotment in case of doubt.

6. Shares are credited and refunds or unblocking are processed

Shares are credited to the beneficiary demat accounts of successful applicants. Unsuccessful applicants have the blocked funds released or get a refund based on the payment mechanism. Communicate with the issue sponsor in case of doubt regarding the operational details and time frames.

7. The shares list and begin trading

Once the listing process is completed, the shares may begin trading on the exchange or exchanges specified for the issue. The opening market price can be above, near or below the issue price. Listing performance is uncertain and can change rapidly as market participants place orders.

What Is the IPO Price Band?

In a book-built IPO, the issuer typically announces a price band within which investors can bid, subject to the terms of the issue. The final issue price is determined during the course of the book building process, and is disclosed in the final offer document/issue announcement.

The price band is not an estimate of the listing price. The upper end of the price band need not be indicative of fair value, or represent a discount to the company's value. The price band is part of the pricing process for the offer.

Investors can assess the valuation offered by the company based on its earnings, revenue, cash flows, assets and other business metrics. Investors can make a peer-group comparison with the company and listed peers, but imperfect comparison can be drawn on account of differences in accounting practices, market conditions and company-specific risks.

How Can Retail Investors Apply for an IPO?

The application process and mechanisms will depend on the IPO and eligibility of the investor. A retail investor needs to confirm the IPO is open, check official prices and details of lots, understand the payment mechanism and deadlines.

Check your demat and bank details

An investor needs to have a demat account to get the allotted shares and provide correct details about the application and the bank account. The name, PAN and other details should be in sync with the requirements of the application route. Providing wrong or discrepant details may lead to rejection of the application.

Review the lot size and application amount

The lot size specifies the minimum quantity that may be applied for in the relevant category. The amount to be bid depends on the final bid price, or the price selected in the permitted band, the lot size and the issue rules. Lot sizes and category limits vary from issue to issue; information of a previous issue should not be used for a current issue.

Submit the application through an authorised channel

Follow the instructions provided by the broker, bank or other authorised application facility. Where a payment-blocking mechanism is used, funds may be blocked in the linked account rather than immediately transferred to the issuer. After applying, retain the application reference and never share passwords, OTPs or sensitive banking credentials with anyone claiming to help with allotment.

Investors interested in understanding the account infrastructure involved can review the stocks and equity-market product overview. Account access is just one of the many steps involved; it does not make an IPO suitable or ensure allotment.

Readers interested in the application process and issue details can see both side by side, in the IPO application process and issue details, along with the official offer document.

What Is IPO Allotment, and Why Might You Not Receive Shares?

Allotment means sharing of the offered shares among the applicants as per the terms of the offer. The number of shares to be offered to each investor category has been defined in the offer documents/issue terms. Usually, demand exceeds the supply.

In such cases, an applicant may be allotted a number of shares less than the applied for shares or no shares at all. The method of allotment depends on the rules governing the issue and the discretion of the authority doing the allotment. An applicant cannot assume that he/she will be allotted shares by applying for a larger number of shares or by making multiple applications by using impermissible/inconsistent details.

Allotment status should be checked through the registrar, the NSE or BSE websites, the issuer or other official channels identified for the IPO. Be cautious of unofficial messages or websites that claim to guarantee allotment, demand a fee to reveal status, or ask for account credentials.

What Does IPO Listing Mean?

Listing means admitting the company’s securities for trading on a stock exchange. Post listing, the price of the security will be determined by market forces of demand and supply.

The issue price is the price at which shares are offered to the public in an initial public offering (IPO). The listing price is the price at which shares commence trading on an exchange. The listing price is always greater than or equal to the issue price.

Listing gains are not assured. A company may list at a premium, at a price close to the offer price or at a discount. Even when a company lists at a premium, the price may later decline. The value of the listing may be influenced by several factors, including market sentiment and trading volume.

Investors should not rely on social media speculations or informal demand estimates as accurate predictors of the listing price. Such estimates may be unofficial and do not necessarily reflect the final price at which shares trade.

How to Read an IPO Offer Document

The offer document outlines the businesses and contains the relevant information for potential investors considering subscribing to the public issue. It is important that investors review the offer document for information concerning the business, risks, the company’s financials, the valuation, the purpose for which the company is raising the funds, and the company’s post-issuance shareholding structure.

Business overview

Identify what the company sells, who buys it, the company’s revenues, what differentiates the company, and what factors affect demand. Look beyond generalized statements and determine the company’s true operating model.

Risk factors

Risks include, but are not limited to, reliance on a few customers, legal and regulatory issues, competition, working capital, financial and operational risks, concentration, reliance on key personnel, and other risks. Consider whether any disclosed risks could impact the business and/or share price.

Financial statements and key metrics

Review the statement of income, statements of financial position and operations, cash flow and profit for the periods provided. Just because a company shows an increase in revenue, does not mean the company is cash generative and/or valued fairly. Review whether the company reports results that include unusual items, and assess whether the company has a track record to validate any claims the company makes about its prospects.

Objects of the issue

For a fresh issue, examine how the company proposes to use the funds. The stated purpose may include capital expenditure, working capital, repayment of borrowings or other disclosed uses. Consider whether the plans are specific, whether they depend on uncertain assumptions and whether the expected benefits are plausible.

Promoters, shareholders and related-party matters

Assess the background of the promoters, changes in shareholding of key shareholders before and after the issue, material related-party transactions and the post-issue shareholding pattern. If existing shareholders are selling through an Offer for Sale (OFS), assess the reason for the sale and the extent of the sale. Assess lock-in periods, if any, and other restrictions described in the offer documents.

Valuation and listed peers

Compared to peers, assess valuation metrics like price-to-earnings (P/E), price-to-sales (P/S), and other appropriate metrics. A ratio, in itself, does not establish a share is undervalued or overvalued. For instance, a low P/E ratio may indicate the share price is low relative to the earnings, or it may be depressed, anticipating poor performance. It may also be low due to high earnings relative to the market. Factors like accounting, business model and growth need to be assessed as well. See our guide on how to value a stock in India to learn about different valuation methods.

IPO Research Checklist for Beginners

When thinking about IPO applications, use a consistent checklist rather than letting yourself get excited about a company that isn't quite ready for application.

• Read the latest offering document and describe the company's business model.

• Understand the mechanics of the fresh issue and OFS split and who the proceeds are distributed to.

• Review the planned use of proceeds and determine if it meets a clear business need.

• Review the financials, cash flows, debt, business risks and other materials.

• Determine promoter and shareholder information and material selling shareholders.

• Review valuation and peer comparison and state the major limitations.

• Verify the issue date, price band and lot size. Understand the applicant eligibility and application rules.

• Think about the potential for a listing below the offer price and consider how you might feel about the price post listing.

• Do not apply with funds that you might need for essential expenses.

• Keep records of your application. Use authorized channels to review allotment status and listing information.

Investors seeking more general context can also read our beginner's guide to the Indian stock market and the stock-market basics guide.

Before You Apply: Understand the IPO Process and Its Risks

An IPO brings together company disclosures, issue pricing, investor applications, allotment and exchange listing. Each stage has its own rules and uncertainties. A thoughtful review should consider both the company's business fundamentals and the mechanics of the offer, and it should complement the official offer document and exchange or issuer disclosures for a particular issue.

Conclusion

An IPO refers to the first public offering of shares by a company. This may include new shares issued by the company, or shares sold by the existing shareholders. The process typically involves the preparation of offer documents, determination of issue terms, solicitation of applications, allotment of shares and listing of shares on a stock exchange. Knowledge of these stages helps the investors understand the difference between a primary issue and later trading on the stock exchange.

New investors need to go beyond identifying an IPO that is currently ‘hot’ in the market. They must understand the business of the company, the offer terms, the intended use of funds, valuation, risks disclosed and the chances of receiving no shares or even losing money after listing. Allotment and listing gains are not guaranteed. Investors wishing to review and learn more about investor resources related to the IPO process are requested to see the IPO product information page.

Readers comparing share broker companies in india can also explore the investor education resources available on InvestEdge360.