IPO Market Explained (Part 2): Process, Steps & Meaning

The IPO Market (Part 2): A Complete Guide to How IPOs Work

Overview of IPO Markets

The journey from a small business idea to a publicly listed company is long and complex. In the previous discussion, we explored how companies evolve through funding stages like seed funding, venture capital, and private equity. Now, the focus shifts to the most crucial milestone in a company’s lifecycle — the Initial Public Offering (IPO).

The IPO market, also known as the primary market, is where companies offer their shares to the public for the first time. This phase is especially important because it often attracts first-time investors who are eager to participate in new opportunities.

Understanding how IPOs work is essential not just for investors, but also for anyone interested in financial markets, business growth, and wealth creation.

Why Do Companies Go Public?

A company doesn’t go public randomly. The decision is usually driven by strategic financial and business goals.

1. Raising Capital for Expansion

One of the main reasons companies launch an IPO is to raise funds for expansion. This includes:

• Building new factories or offices
• Investing in technology
• Expanding into new markets
• Increasing production capacity

This is often referred to as CAPEX (Capital Expenditure).

2. Reducing Debt

Some companies use IPO funds to repay existing loans. By doing this:

• Interest costs reduce
• Financial health improves
• Profitability increases

3. Providing Exit to Early Investors

Early investors like:

• Angel investors
• Venture capitalists
• Private equity firms

invest in the company during its early stages. An IPO gives them an opportunity to sell their shares and realize profits.

4. Rewarding Employees (ESOPs)

Employees often receive Employee Stock Options (ESOPs) as incentives. Once the company goes public:

• These shares gain real market value
• Employees can sell them for profit
• It boosts employee motivation and retention

5. Increasing Visibility and Credibility

A listed company gains:

• Public trust
• Brand recognition
• Media attention

This increased visibility can lead to better business opportunities and partnerships.

6. Risk Diversification

Instead of depending on a few large investors, ownership is spread across thousands of public investors. This reduces financial risk for promoters.

Role of Merchant Bankers (Lead Managers)

Once a company decides to go public, the first major step is appointing a merchant banker, also known as a Book Running Lead Manager (BRLM).

They play a central role in the IPO process.

Key Responsibilities

1. Due Diligence

• Verify all company information
• Ensure legal compliance
• Issue a due diligence certificate

2. Preparing IPO Documents

• Draft the Draft Red Herring Prospectus (DRHP)
• Include financials, risks, and business details

3. Underwriting Shares

• Agree to buy unsold shares (if any)
• Ensure minimum subscription levels are met

4. Pricing Strategy

• Decide the price band
• Balance investor interest and company valuation

5. IPO Marketing (Roadshows)

• Promote the IPO to investors
• Conduct presentations and media campaigns

6. Coordination

• Appoint registrars, bankers, and advertising agencies
• Manage the entire IPO process smoothly

Merchant bankers act as the bridge between the company and investors.

Step-by-Step IPO Process

Every IPO in India follows strict regulations set by the Securities and Exchange Board of India (SEBI).

Here is the complete sequence:

1. Appointment of Merchant Banker

The company selects one or more lead managers.

2. Filing with SEBI

The company submits a registration statement containing:

• Business details
• Financial performance
• IPO purpose

3. SEBI Review

SEBI evaluates the application and either:

• Approves it
• Requests changes
• Rejects it

4. Draft Red Herring Prospectus (DRHP)

The DRHP is a crucial document for investors. It includes:

• IPO size
• Number of shares offered
• Use of funds
• Financial statements
• Business model
• Risk factors
• Management details

Investors should always read the DRHP before investing.

5. IPO Marketing (Roadshows)

Companies promote their IPO through:

• Advertisements
• Investor meetings
• Media campaigns

6. Price Band Determination

A price range is set (e.g., ₹100–₹120). Investors can bid within this range.

7. Book Building Process

Investors place bids at different prices. This helps in:

• Discovering the fair price
• Gauging demand

8. Closure of Issue

After a few days:

• Bidding closes
• Final price (cut-off price) is determined

9. Listing on Stock Exchange

The company’s shares are listed on exchanges like:

• NSE
• BSE

The stock begins trading publicly.

What Happens After the IPO?

Once the IPO is completed, the stock moves from the primary market to the secondary market.

Primary Market

• Investors buy shares directly from the company
• Happens during the IPO

Secondary Market

• Shares are traded between investors
• Happens after listing

In the secondary market:

• Prices fluctuate daily
• Investors buy and sell shares
• Market forces (demand & supply) determine prices

This is where most trading activity occurs.

Key IPO Terminology Explained

Understanding IPO jargon is important for making informed decisions.

Under-Subscription

• Demand is less than available shares
• Indicates weak investor interest

Over-Subscription

• Demand exceeds available shares
• Example: 2x means twice the demand

Green Shoe Option

• Allows issuing extra shares (up to 15%)
• Used in case of high demand

Fixed Price IPO

• Shares are offered at a fixed price
• No price band

Price Band

• Range within which investors bid

Cut-Off Price

• Final price at which shares are allotted

Recent IPO Examples in India

Here are some notable IPOs:

These examples show how different companies raise funds through IPOs across industries.

Key Takeaways

• IPO is the process through which a company offers shares to the public for the first time.
• Companies go public to raise funds, reduce debt, reward employees, and gain visibility.
• Merchant bankers manage and guide the IPO process.
• SEBI regulates IPOs in India to protect investors.
• The DRHP is the most important document for investors.
• Most IPOs use the book-building method for price discovery.
• After listing, shares are traded in the secondary market.

Final Thoughts

The IPO market is one of the most exciting parts of the financial world. It represents growth, opportunity, and transformation. For companies, it’s a gateway to expansion. For investors, it’s a chance to participate in a company’s growth story from an early stage.

However, IPO investing requires careful analysis, especially of company fundamentals and DRHP details. Blindly applying for IPOs based on hype can lead to losses.

As you move forward, understanding the secondary market will help you complete the full picture of how stock markets function in real life.

FAQ

1. What is an IPO in simple terms?
An IPO (Initial Public Offering) is when a company offers its shares to the public for the first time to raise money.

2. Why do companies launch IPOs?
Companies go public to raise funds, reduce debt, give exits to early investors, reward employees, and increase visibility.

3. What is DRHP in IPO?
DRHP (Draft Red Herring Prospectus) is a document that contains all important details about the company, including financials, risks, and IPO purpose.

4. What is the book-building process?
It is a method where investors bid within a price range to help determine the final IPO price.

5. What is the difference between primary and secondary market?
The primary market is where shares are issued during an IPO, while the secondary market is where shares are traded after listing.

6. What does oversubscription mean in IPO?
Oversubscription happens when the demand for shares is higher than the number of shares offered.

7. Who regulates IPOs in India?
IPOs in India are regulated by SEBI (Securities and Exchange Board of India).