What is an IPO? A Beginner’s Guide to Initial Public Offerings

For many new investors, Initial Public Offering or IPO is the first step into the stock market. When a company goes public, it offers its shares to investors for the first time, giving retail investors a chance to be part of the company’s growth story right from the beginning.. In this blog, we’ll explain what an IPO is, the purpose of an IPO, how companies raise funds through IPO, and how companies receive funds after IPO allotment.

What is an IPO?

Initial Public Offering or IPO is the process through which a private company offers its shares to the public for the first time. After an IPO, the company becomes a publicly listed entity, and its shares begin trading on stock exchanges like NSE or BSE.

Before the IPO, ownership usually lies with the founders, early investors, or private equity firms. Once the IPO takes place, retail investors can also purchase shares, marking a major step that allows the public to join the company’s growth journey.

Purpose of an IPO: Why Do Companies Go Public?

Launching an IPO helps a company achieve several objectives:

• Raising Capital for Growth: Companies often need funds to expand, launch new products, open branches, or invest in technology. Instead of borrowing, they raise money by selling shares to the public.
• Increase Visibility & Credibility: Being listed on a stock exchange enhances the company’s reputation and makes it easier to attract new investors, partners, and even customers.
• Paying Off Debts: Some companies use IPO proceeds to reduce their financial burden by repaying existing loans.
• Liquidity for Early Investors: Founders, venture capitalists, and private equity investors who supported the company in its early days may sell part of their holdings in the IPO to book profits.

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How Companies Raise Funds Through an IPO

When a company launches an IPO, it can raise funds by issuing and selling new shares to the public. This process marks its transition from a private to publicly traded entity, allowing it to access a larger pool of capital from institutional investors, high-net-worth individuals, and retail investors.

Ways a Company Raises Funds

Fresh Issue of Shares

The most direct way a company raises funds is by creating and selling new shares to the public. Fund raised from this sale goes directly into the company's accounts and are used for purposes like:

• Funding business expansion: Raised capital can be used to set up new factories or offices, purchase new equipment, or expand into new markets.
• Research and Development (R&D): Funds can be used to launch new products or improve existing products to stay competitive.
• Repaying debt: Companies may use the IPO proceeds to pay off existing debt, strengthening their balance sheet and reducing interest expenses.
• Acquisitions: Capital can be used for mergers and acquisitions to expand and diversify the company's product portfolio.

Offer for Sale (OFS)

IPO can also include an Offer for Sale where existing shareholders, such as founders or early investors, sell their existing shares to the public. In this case, the funds go to the selling shareholders, not the company. While this doesn't directly raise new capital for the company, it provides liquidity for early backers and enables them to monetize their investment.

How Companies Receive Funds from an IPO

When investors apply for an IPO, their funds are not immediately debited. Instead, the application amount is blocked in their bank account using the Application Supported by Blocked Amount (ASBA) facility. After the bidding closes and shares are allocated, the final price is determined.

• If an investor receives a full allotment of shares, the entire blocked amount is debited from investor's account and transferred to the company.
• If an investor receives a partial allotment, only the amount corresponding to the allotted shares is debited, and the remaining blocked amount is released.
• If no shares are allotted, the entire blocked amount is released to the investor.

FAQs

• What do you mean by IPO?  
  An IPO is when a private company offers its shares to the public for the first time, becoming a publicly listed company on stock exchanges.
• How does an IPO work?  
  A company files documents with SEBI, sets a price band, invites investors through the IPO application process, allots shares based on demand, and finally lists on the stock exchange.
• Is IPO profitable?  
  IPOs can be profitable if company grows and demand is high at listing. However, returns aren’t guaranteed, and oversubscription or market volatility can affect profits.
• Is an IPO a good investment?  
  An IPO can be a good investment for long-term growth, but it carries risks. Research the company’s financials, market potential, and fundamentals before applying.