Initial Public Offering Meaning and Definition

As someone who is interested in the stock markets, you must have, on several occasions, come across the term: Initial Public Offering (IPO). You could have then wondered: What is IPO and what are its types? Read on to know about the crucial aspects of IPO.

What Is IPO In Stock Markets?

IPO definition implies the process by which any private company becomes publicly listed on stock exchanges. When a company announces its IPO, it means that instead of the company’s shares being held by a minuscule number of private people, now the shares will be offered to the public. This, in turn, will allow the company’s shares to be freely traded in the exchanges.

To put it simply, a company gets listed stock exchanges through the process of IPO.

IPO Meaning In Stock Markets

Once a company becomes publicly traded, it has to sell a part of its ownership to investors. Owning a stock of a particular company would provide part-ownership to an investor. Typically, a company initiates IPO for the following purposes:

  • To infuse fresh equity capital.
  • To facilitate the trading of its assets.
  • To raise capital for various requirements.
  • To monetize the investment of its private stakeholders.

The Process Of IPO

To know the IPO definition, you have to understand its process. Before announcing an IPO, a company approaches an investment bank to manage the IPO’s process. The investment bank then evaluates and prepares the financial details of the IPO in the underwriting agreement. The underwriting agreement along with a registration statement are now submitted to SEC. If the documents filed are in tune with the rules and regulations of the SEC, it approves them and allows the company to announce a date for its IPO.

Here’s more on the topic, IPO Process in India

Types of IPO

To understand IPO meaning in stock markets, you have to understand the types of IPOs. There are two types of IPOs:

1. Fixed Price Offering:

Here, the company announces the full price of its IPO, beforehand. It means investors taking part in the fixed price offering IPO have to pay the full amount while making applications.

2. Book Building Offering:

Here, the company offers its stock price at a 20% band and asks the investors to place their bids for deciding the final price of its stocks. The investors, in turn, are required to specify the amount that they are willing to pay along with the number of shares they want to purchase. The lowest price provided by investors is called Floor Price, while the highest bidding price is known as the Cap Price. You must understand that in this type of IPO exercise, the price-determination of a company’s stock is directly contingent upon the bidding process of investors.

Things You Must Know Before Investing In An IPO

Now that you are aware of what is IPO in stock markets, here’s a look at the process of an IPO and the steps well-informed investors must take, before investing their hard-earned money in IPOs.

  • Make An Informed Decision:Before investing in an IPO, you must read the company’s prospectus thoroughly. It will allow you to know about the company’s business plans and the reason why it is initiating an IPO.
  • Get Access To The Requisite Funds: Once you have made an informed decision to apply for an IPO, you must arrange for the requisite funds. You can use your existing savings or take a loan for investment purposes.
  • Open a Demat And Trading Account:Now you are required to open a Demat Account and a Trading Account. While your stocks are held electronically in the Demat Account, the Trading Account will allow you to place purchase and sell orders.
  • Making An Application For The IPO: You have to compulsorily avail the Applications Supported by Blocked Account (ASBA) facility, before making an IPO application. ASBA applications are provided to investors; both in the electronic and physical format. Here, you must keep in mind that ASBA authorises a bank to block the investor’s money for subscribing to an IPO. Thus, till the time the shares are allotted, after the IPO process, your money will remain with the bank.
  • The Bidding Process: If the company has announced a book building IPO, you have to make an application in tune with the company’s quoted Lot Size. This is the minimum number of shares you must apply for. Now you are required to place a bid within the price range.
  • The Process Of Allotment: If you receive full allotment or the actual number of shares for which you made an application, you will get a Confirmatory Allotment Note (CAN) within six working days of the IPO. But in the case of higher demand, you can also get partial allotment. In this case, the banks will unlock the blocked amount, in tune with allotments made.

You may also like, IPO Investment Strategies and Tips

Important Terms Pertaining To IPO

To comprehend IPO meaning in stock markets, you must be aware of certain key terms. Here’s a look:

Draft Red Herring Prospectus (DRHP):

In the case of book building IPOs, the company provides its offer document or preliminary registration document detailing the reasons for the IPO, the risks involved and how the money will be used by the company. Some of the important DRHP details include:

  • Balance sheet.
  • Earning statement.
  • Net proceeds.
  • Legal opinion of the listings.
  • Underwriting document’s copy.

Green Shoe Option: This option allows the underwriter of an IPO to provide additional shares to the public, in the case of high demand. The additional equity shares, however, can only be issued up to the specified amount.

Underwriters: Underwriters not only assist a company to underwrite its shares but also commit subscribing to the balance stocks, in the case of low demand. Underwriters can be of the following categories:

  • Bankers.
  • Financial institutions.
  • Merchant bankers.
  • Brokers

Conclusion

For a prudent investor, merely knowing IPO definition won’t suffice. You must have a clear understanding of the company’s vital financial benchmarks before investing in IPOs. Alongside, do remember to choose a trusted and reliable financial partner to help you identify the suitable IPO investment opportunities.

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