Have you ever thought about the companies in the stock market and where they come from? They trade in the public stock market, but were they always there? How does a company go from a private company when it is formed to a publicly traded company in the stock market?
To answer these questions, today we will uncover the concept of Initial Public Offering (IPO).
Let’s begin by first understanding the simple idea of owning a company. A company is typically owned by multiple people and entities, all of which are called shareholders. It is quite intuitive, as these people own a share of the company and are therefore called shareholders.
In the case of a private company, the shareholders are usually the founders and investors, and often also the employees.
In a publicly traded company, in addition to the above, investors in the stock market that purchase shares of the company, also become shareholders by default.
Now let’s dive into what an Initial Public Offering (IPO) is.
As the term suggests, an IPO is when a company offers its shares to the public for the first time. Before an IPO, a company is private with a limited number of shareholders, like the founders, early investors, and employees. Going public through an IPO marks a significant milestone, opening doors to new capital and growth opportunities. When a company comes out with its IPO, we also call it ‘going public’.
Now, while we stand to benefit by gaining an option to invest in the company by it going public, let’s understand from a company’s perspective why it would choose to go public.
Why Do Companies Go Public?
1. Raising Capital: Companies raise funds to expand, invest in new projects, or pay debts. When a company becomes open to the public, shareholders buy shares in the company which serves as increased capital for the company.
2. Enhancing Credibility: Being listed on a stock exchange boosts a company's public image. Since the company becomes more recognized when it begins to trade on the stock market, it gains more potential reputation and credibility.
3. Liquidity: IPOs provide an exit route for early investors and a chance for employees to cash in on their stock options.
Shareholders of a company, while the company is private have limited options for encashing their shares. When the company starts to trade on the stock market, it becomes easy for the shareholders to exit the company and liquidate their shares.
Now, if you are probably wondering why you need to know about IPOs, here’s what’s in it for you.
Let’s talk about how you can potentially stand to gain by participating in an IPO.
How Can You Invest?
Three pointers for you to keep in mind if you choose to consider participating in an IPO.
1. Do Your Homework: Research the company, read its prospectus, and understand the risks involved. Know the company well, understand the business it is in, and whether you find the IPO promising.
2. Open a Demat Account: You need these accounts to apply for an IPO and trade shares. A Demat account allows you to trade shares in the stock market.
3. Application Process: Apply through your bank or broker, deciding how many shares you want and at what price.
Now, let’s say you do apply for an IPO.
What happens next?
Either you get the allotment of shares or you don't. Let’s look at it in more detail.
When you apply for an IPO, shares are not guaranteed to everyone due to high demand. The allotment process is like a lucky draw. If the IPO is oversubscribed (more demand than available shares), a lottery system is often used to decide who gets the shares. Your chances depend on the number of applicants and shares available.
Scenario 1: You Get the Allotment
If you're allotted shares, that’s great! It means you now own a part of the company.
The amount you bid for the shares gets deducted from your bank account, and you receive an email or SMS confirming your allotment.
The shares are credited to your Demat account. You can see them, hold them, or even sell them once they're listed on the stock exchange.
Scenario 2: You Don't Get the Allotment
Sometimes due to high demand, you might not get any shares. It's like not getting tickets to a sold-out concert.
The money you had blocked for the IPO is released back into your bank account. You get a full refund, no deductions.
Now, do you always stand to gain if you get the allotment of shares from an IPO?
While IPOs can be exciting and rewarding, they come with risks. Market volatility, overvaluation, and lack of historical performance data can affect IPO stocks. While usually, a company would go public if it was confident in its performance, there can be times when it does not perform well due to various reasons. Investing in such an IPO can be financially detrimental.
It's important to invest wisely, not just follow the hype.
After an IPO, the company's performance and share price depend on various factors like financial health, market conditions, and management decisions. As a shareholder, you can hold onto your shares, sell them, or buy more, depending on your investment strategy and goals.
IPOs open a window to the corporate world, offering a chance to be part of a company's growth story. For the youth of India, understanding and participating in IPOs can be both a learning experience and an investment opportunity.
Remember, informed and cautious investing is the key.
So stay tuned, until next time!
FAQs about IPOs in India:
1. What factors should be considered when choosing which IPO to invest in?
When selecting an IPO for investment, consider the company's business model, growth potential, financial health, market competition, and the experience of its management team. It's also crucial to understand the industry's future prospects and how the company stands out in its sector.
2. How does an IPO affect the valuation of a company?
An IPO often increases a company's public profile and credibility, potentially raising its valuation. The process involves setting a market price for the company's shares, which is influenced by investor demand, perceived potential, and financial performance.
3. Can investing in IPOs be a part of a long-term investment strategy?
Yes, IPOs can be part of a long-term investment strategy if you choose companies with strong growth potential and sound business fundamentals. It's important to assess whether the company fits into your overall investment goals and risk tolerance.
4. What is the role of market timing in investing in IPOs?
Market timing can be crucial in IPO investing. It involves understanding market conditions and sentiment at the time of the IPO. A bullish market might offer higher initial returns, whereas a bearish market could affect the initial performance of the IPO.
5. How can one stay updated about upcoming IPOs in India?
You can stay informed about upcoming IPOs by following financial news platforms, subscribing to newsletters from stock exchanges, and keeping in touch with brokerage firms. Many financial websites and apps also provide updates on upcoming IPOs.
6. What should investors do if they don't receive an allotment in an IPO?
If you don't receive an allotment in an IPO, consider it as part of the investment process. You can either try for future IPOs or look for other investment opportunities. Remember, investing is about diversification and not putting all your eggs in one basket.
7. Are there any specific risks associated with investing in IPOs of tech startups?
Investing in tech startup IPOs comes with unique risks like rapid market changes, high competition, and the potential for overvaluation. Tech startups often prioritize growth over profitability, which can be risky if the company doesn't achieve expected growth rates.