What is IPO and how to invest in IPO?

An IPO is an initial public offering. In an IPO, an unlisted company decides to raise funds through the sale of securities or shares for the first time to the public. In other words, an IPO is making shares available for purchase by the general public in the primary market. A primary market deals with new securities being issued for the first time.  After listing on the stock exchange, the company becomes a publicly-traded company and the shares of the firm can be traded freely in the open market.

Key IPO Terms

The world of finance is full of jargons. But don’t worry about the jargons of IPO as we have demystify them for you:

Common stock: Units of ownership in a public company that typically entitle holders to vote on company matters and receive company dividends. When going public, a company offers shares of common stock for sale.

Issue price: The price at which shares of common stock will be sold to investors before an IPO company begins trading on public exchanges. Commonly referred to as the offer price.

Lot size: The smallest number of shares you can apply for in an IPO. If you want to apply for more shares, you must bid in multiples of the lot size.

Price band: The price range in which investors can bid for IPO shares, set by the company and the underwriter. It’s generally different for each category of investor. For example, qualified institutional buyers might have a different price band than retail investors like you.

Underwriter: The investment bank that manages the offering for the issuing company. The underwriter generally determines the issue price, publicises the IPO and assigns shares to investors. Additionally, they also guarantee the purchase of a specific number of shares. In case they do not sell as per guaranteed, underwriters cover that risk, and ensures the public offer sails through.

DRPH:  A document created by the IPO company that discloses information about its business, strategy, historical financial statements, recent financial results and management. It has red lettering down the left side of the front cover and is sometimes called the “red herring.”

Types of IPOs

Now that you have understood key terms related to an IPO. Let’s look at the two major categories of IPOs offered by companies.

Fixed price offering: Fixed price offering is pretty simple. The company announces the price of the initial public offering in advance. So, when you participate in a fixed price initial public offering, you agree to pay in full.

Book building offering: In the book building offering, the stock price is offered in a 20% band, and interested investors place their bid. The lower level of the price band is called the floor price, and the upper limit, cap price. Investors bid for the number of shares and the price they want to pay. It allows the company to test interest for the initial public offering among investors before the final price is declared.

Applying for an IPO

Nowadays, it has become easier to apply for an initial public offering because of the online application process.

The first important thing is funding. Whether it is a fixed price or a book building IPO, you will have to make a payment in advance, and for that, you must have funding ready. Investors can use their savings or take a loan from a bank or NBFC for the purpose.

However, without a dematerialised account (where shares are held in digital form), you can’t invest in stocks. So, the next thing you need is to open a Demat account. Select a reputed broker with a track record to have a Demat account.

You can use the Demat account not only for IPOs, but to receive all sorts of investment instruments like gold bonds, corporate bonds, shares, and more.

The online process is an easy way to apply. You can do it from the investor portal on the broker’s website or by downloading the Application Supported by Blocked Account (ASBA) form from your bank’s net-banking platform. It allows banks to block funds in the applicant’s account against your bidding for the IPO.

If you apply through the broker, you need to use UPI enabled payment gateways to make payment. In either case, cheques and demand draft payments are not accepted for bidding.

Remember, while a company may create a lot of buzz in the market just before launching an IPO, you need to research the company thoroughly and consult your investment advisor before investing.