IPO Basics: What an Initial Public Offering Is and How It Works
An IPO, or Initial Public Offering, is the process through which a company offers its shares to public investors for the first time. After completing the applicable process and listing requirements, the company's shares may become available for trading on a stock exchange.
What Is an IPO?
Before becoming publicly listed, a company may be privately owned by founders, promoters, investors or other shareholders. Through an IPO, the company can offer shares to eligible public investors according to the applicable offer terms and regulatory requirements.
An IPO investment involves risk. The availability of an IPO, eligibility requirements, application process, allotment and listing performance can vary. Investors should review official offer documents and applicable information carefully before making an investment decision.
Why Does a Company Launch an IPO?
Companies may go public for different reasons. Depending on the offer structure, the funds raised may be intended for purposes described in the official offer documents.
- Raising capital for business activities or expansion.
- Repaying or reducing certain borrowings.
- Funding future business plans.
- Providing an opportunity for existing shareholders to sell shares, where applicable.
- Supporting other objectives described in the offer documents.
How Does an IPO Generally Work?
The IPO process involves several stages and participants. The exact process can depend on the applicable regulations, type of issue and market requirements.
- The company prepares for the public issue.
- Relevant offer documents and disclosures are prepared.
- The offer may be made available for eligible investors to apply.
- Applications are processed according to the applicable rules.
- Shares may be allotted to successful applicants.
- After listing, the shares may trade on the relevant stock exchange.
A company decides to raise funds from public investors through an IPO. Eligible investors submit applications according to the issue terms. If shares are allotted, those shares may later be credited according to the applicable process and become tradable after listing.
IPO Price and Price Band
Depending on the type of issue, an IPO may have a fixed price or a price range known as a price band. Investors should review the official issue details to understand how the final price and application process apply to that particular offer.
What Is IPO Allotment?
IPO allotment refers to the process through which shares are allocated to successful applicants according to the applicable issue rules and demand for the offering.
Applying for an IPO does not guarantee that an investor will receive shares. In heavily subscribed issues, the number of applicants may exceed the number of shares available for allocation.
What Happens on Listing Day?
After the applicable allotment and listing process is completed, the shares may begin trading on the stock exchange. The market price can move above or below the issue price and may change throughout the trading period.
Listing performance is uncertain. A strong level of demand before listing does not guarantee future returns.
Important Things to Review Before Applying
- The company's business and industry.
- Financial information and relevant risks.
- The purpose of the issue.
- The price or price band.
- The offer structure and available categories.
- Valuation and other relevant financial factors.
- Risk factors described in the official documents.
IPO Risks to Understand
Like other equity investments, IPO investments involve market and business risks. The value of shares can rise or fall after listing.
- Market prices can be volatile.
- There is no guarantee of allotment.
- Listing gains are not guaranteed.
- The business may face operational or industry risks.
- Company performance can affect the share price over time.
- Past market activity does not guarantee future results.
IPO vs Listed Shares
An IPO generally refers to the initial offering of shares to public investors. Listed shares are shares that are already available for trading on a stock exchange after listing.
Both involve investment risk, but the way an investor participates and the available information at different stages may vary.
Common Mistakes to Avoid
- Applying only because an IPO is receiving attention.
- Assuming every IPO will generate listing gains.
- Ignoring the company's financial information and risk factors.
- Investing money that may be needed for essential expenses.
- Making decisions without reviewing official issue documents.
- Confusing allotment with guaranteed profit.
Key Takeaways
- An IPO is generally a company's first public offering of shares.
- Eligible investors may apply according to the issue terms and applicable rules.
- Allotment is not guaranteed.
- After listing, share prices can rise or fall.
- Investors should study the business, financial information, valuation and risk factors before investing.