Explain Like I'm 5: What is an IPO?

Deepika Chelani
Updated: 27 Dec 2021, 01:08 PM IST
TL;DR.

An initial public offering (IPO) is a way through which a private company becomes public by selling stock to the general public for the first time following which, its shares get listed on a stock exchange. We decode the entire process for you here.

An IPO is the process by which a private company can go public by offering its stock to the general public for the first time.

An IPO is the process by which a private company can go public by offering its stock to the general public for the first time.

An initial public offering (IPO) is a method through which a private business identifies itself as public by offering its stock to the public for the first time. 

A firm can raise equity capital by issuing stocks to the public in an initial public offering, or existing shareholders can sell their shares to the public without generating any new capital. 

Through this way, the company's name is placed on the stock exchange and its stocks are made available for the investors.

How does a firm issue an initial public offering (IPO)?

The company employs an investment bank to manage the IPO before it goes public. In the underwriting agreement, the firm and the investment bank collaborate on the financial transaction specifics of the IPO.

They then file the registration statement with the Securities and Exchange Board of India along with the underwriting agreement. The SEBI thoroughly examines the given material, and if it is deemed to be correct, it sets a date for the IPO to be declared.

When is it done and what are the benefits?

The fundamental goal of an IPO is to generate liquidity. It also gives the company's employees, who are also current investors, a way out.

Companies conduct initial public offerings (IPOs) to increase the exposure and marketing of their goods and services in the market.

Every company's primary goal is to raise equity money through an initial public offering (IPO). It might be for a new or expanding business, to enhance infrastructure, to develop their business to pay interest on loans, and so on.

In a competitive market, a public firm may typically issue more stock. As the equities may be issued as an integrated package, this will pave the way for mergers and acquisitions.

A brand's achievement in getting its name noticed in the stock exchange is a source of pride and credibility for any firm.

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An IPO is a method through which a private business identifies itself as public by offering its stock to the public for the first time.

How is the IPO price determined?

There are two types of IPOs, and the issue price is determined based on the type of the IPO.

Fixed price offering

In a fixed price IPO, the price of the issue is decided by the company itself. The company, with the help of its underwriters, estimates the financial aspects of the company while deciding the issue price. Once the order is printed, the price is made public and the floor is open for the investors to buy the securities.

50% of the allotment is set aside for investments of less than 2 lakhs, with the remainder reserved for high-value investors. In this process, the market demand of the stocks can be determined only after the issue is closed. Hence, the issue price does not depend on the demand of the stocks.

Book building offering

In book building IPO, the price of the issue is decided as the investors bid for the shares of the company. The company publishes the price band in the order document wherein the upper limit is known as cap price and lower limit is known as floor price. The investors bid for prices according to the price band.

50% of allotment is reserved for the Qualified Institutional Bidders (QIBs), 35% for small Investors, and the remainder for other Investors. In this process, the market demand of the stocks can be determined every day as the bidding goes on.

Conclusion

IPOs attract a lot of media interest, some of which is intentionally fostered by the firm that is going public. IPOs are popular among investors in general because they create dramatic price fluctuations on the day of the IPO and immediately thereafter. 

This can sometimes result in huge gains, but it can also result in large losses. IPOs are generally considered a good option for the investors who have a detailed knowledge about the companies offering them.

 

First Published: 27 Dec 2021, 01:08 PM IST
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