What is an IPO?- Meaning, Process, Types, Benefits & Risks

You are finally making your Instagram account public. You were private, selective, and low-key. But now you want reach, followers and growth - coming with attention, opinions and expectations. And when a company does the same, going public from private, it is through IPO, Initial Public Offering.

About IPO

IPO is when a private company makes its stock available to the public for the very first time by listing on a stock exchange. It’s like inviting the general public to own a piece of the business. For the company, it's a major capital-raising strategy. For investors, it's a unique opportunity to gain early access to potentially high-growth companies.

However, not every IPO leads to glory, some are driven by pressure, regulatory needs, or even clever risk transfer to unsuspecting investors.

While IPOs can be exciting, it's crucial to remember that not every IPO is a golden ticket. Inherent risks always accompany the potential for gains.

Why Do Companies Launch an IPO?

IPO is not just ringing the Stock exchange bell; there are numerous reasons a company decides to go public. The most obvious is to raise capital. Apart from it, the company goes public for various financial and strategic reasons.

Raising Growth Capital: This is the most fundamental reason. An IPO allows a company to raise a significant amount of capital by selling shares to the public investors. This capital is then used for Business Expansion, paying off the Company’s debts, Working Capital, and Mergers & Acquisitions.
Liquidity for Existing Shareholders: An IPO provides a crucial exit strategy for early investors to convert their paper wealth into real cash.
Enhanced Visibility & Credibility: Going public puts the company in spotlight, enhancing the company’s visibility and brand recognition. A publicly listed company often signals stability, transparency, and a commitment to higher corporate governance standards, enhancing credibility.
Acquisition Currency: Publicly traded stock can be used as a "currency" for acquiring other companies without depleting cash reserves. This offers flexibility in M&A strategies.
Attracting & Retaining Talent: Offering stock options or grants in a publicly traded company can be a powerful incentive for attracting and retaining top talent, as employees can directly participate in the company's success and gain liquidity for their shares.

For instance, Swiggy’s 2024 IPO raised ₹11,324 crore (₹4,499 crore fresh issue, ₹6,828 crore OFS). Aimed at boosting growth and tech, it was oversubscribed 3.59x. Shares listed at ₹412 against the issue price of ₹390, debuting with a premium and strong investor confidence.

The IPO Process: Behind the Scenes

Hire an Investment Bank:

To initiate an IPO, a company hires one or more investment banks (underwriters) to assess its financials, structure the offering, and draft an agreement outlining the capital to be raised, however, underwriters don’t bear all the associated risks.

Filing RHP & Register with SEBI:

The company and underwriters file a registration statement and Draft Red Herring Prospectus (RHP) with SEBI and the Registrar of Companies, disclosing all financial, business, and risk details. SEBI reviews it for compliance, and only upon approval can the company proceed with announcing the IPO date.

SEBI Review & Approval:

Concurrently with the SEBI approval process, the company applies to list its shares on major Indian stock exchanges like the National Stock Exchange (NSE) and/or the Bombay Stock Exchange (BSE). The exchanges review the company's eligibility and compliance with their listing requirements. For Example, despite being India’s top stock exchange, NSE’s IPO has been delayed for years due to SEBI’s concerns over governance issues, especially the 2015 co-location scandal.

Roadshow:

Before an IPO goes public, company executives and merchant bankers conduct a two-week "roadshow" across major financial centres to present facts and figures to Qualified Institutional Buyers and other large investors to generate interest, gauge demand, and potentially offer early stock purchase opportunities at a pre-public price.

IPO Pricing:

Companies price IPOs using either a Fixed Price (one set rate) or Book Building (bids within a price band). But steep pricing can backfire, just like Paytm’s ₹18,300 crore IPO in 2021, which was fully subscribed but still listed 9% lower and closed 27% down due to overvaluation and profit concerns.

Available to the Public:

The IPO opens to the public for around 5 working days, during which investors can apply through designated banks or brokers. It's crucial to time the launch to avoid competition and maximise returns. Once bidding closes, the company submits the final prospectus with share allotment details and final issue price to SEBI and the ROC.

Final Allotment:

Once the company finalises the IPO price, it allots shares, fully or proportionately (in case of oversubscription) and credits them to investors’ demat accounts within 10 days. It issues refunds for unallotted shares, and trading begins on the stock exchange.

Types of IPOs

Image generated with ChatGPT

There are two types of IPOs – Book Building Issue & Fixed Price Issue, the company can decide upon either of them, or could use a hybrid.

Book Building Method: In this approach, the company sets a price band and invites investors to bid within it. Market demand during the bidding period determines the final share price (Cut-off Price).
Fixed Price Method: Here, the company sets a single, predetermined share price, requiring investors to pay the full amount upfront without any price discovery during the bidding process.

Benefits of IPOs to Investors

Investing in Initial Public Offerings brings many benefits to the investor, some of them are-

Early Entry: IPOs allow investors to buy shares before the company is listed on the stock exchange, offering a chance to invest at an early stage and potentially benefit as the company grows.

Potential Listing Gains: Many IPOs list at a price higher than their issue price, giving investors immediate profits on the listing day, a popular reason why IPOs attract so much attention.

Ownership in Growing Companies: Buying into an IPO means becoming a shareholder in a business that’s often in its expansion phase, which could translate into long-term value as the company scales.
Diversification: IPOs often introduce new businesses or sectors to the market, helping investors spread their risk by adding variety to their existing portfolio.

Risks and Red Flags to Watch

Image generated with ChatGPT

High Valuation: When companies price their IPOs aggressively compared to industry peers or their performance, they may overvalue the stock.
Weak Promoter Background: Promoters with a history of poor governance, lack of industry experience, or past failures may signal a lack of leadership and long-term vision.
High Debt: A company burdened with heavy debt may struggle with repayments, making it financially unstable and vulnerable during downturns.
No Profit Track Record: Companies, especially startups, with no history of profitability pose higher risks as future earnings are uncertain and speculative.
Confusing Use of Proceeds: When companies fail to clearly explain how they’ll use the raised funds in the IPO prospectus, they signal poor planning or possible misuse.
Avoid IPOs which are 100% OFS: Avoid IPOs that are 100% Offer for Sale (OFS), as no fresh capital is infused into the company. It means existing shareholders are just offloading their stake, indicating limited growth intent or exit strategy rather than expansion.

Example- Fino Payments Bank (IPO in 2021)
Red Flags: High Valuation + No Profit Track Record + Limited Promoter Confidence
Fino Payments Bank’s 2021 IPO raised ₹1,200 crore (₹900 crore OFS, ₹300 crore fresh issue). Priced at a high P/E of 135x despite low profitability (₹20.5 crore profit, 2.42% RoNW), it listed at Rs. 548, 5.7% below the issue price of Rs. 577 and fell 35% in 3 months—reflecting valuation concerns.

Also, check - What is GMP in IPO?

Conclusion

An Initial Public Offering marks a company’s grand debut on the public stage, widely anticipated and full of potential. However, not every IPO results in sustainable growth or long-term value creation. For companies, it's a bold step toward growth and market credibility. For investors, it's a chance to get in early, but only if you've researched well. “In the world of IPOs, enthusiasm has its place—but informed insight is paramount. Research thoroughly, invest thoughtfully, and never forget: not every newly listed stock is destined to shine.”

About the Author

Jagriti Soni

I am a writer who is curious to learn and explore new things and share the same with my readers. I craft content that’s easy to understand, with a dash of wit to keep things light and relatable.

View All Articles by Jagriti Soni