Initial Public Offering (IPO), Meaning, Types, Objectives, Eligibility

Initial Public Offering (IPO) is the process through which a company offers its shares to the public for the first time. After launching an IPO, the company becomes a publicly listed company and its shares are traded on a stock exchange such as the National Stock Exchange or the Bombay Stock Exchange.

An IPO allows ordinary people to buy shares of a company and become its part-owners. It is the stage when a company moves from private ownership to public ownership.

Initial Public Offering (IPO) Objectives

• The main objective of an Initial Public Offering (IPO) is to raise money from the public. Companies use this money to expand their business, set up new units, develop new products, invest in technology, or enter new markets.
• Another objective is to repay existing loans and reduce debt. This improves the financial health of the company.
• IPOs also increase a company’s visibility and credibility. Once listed, the company gains public trust because it must follow strict rules and disclose its financial details.
• For early investors and promoters, an IPO provides an opportunity to sell part of their shares and earn returns on their investment.

Types of Initial Public Offering (IPO)

There are mainly two types of Initial Public Offering (IPO): 

• Fresh Issue: The company issues new shares and receives the money raised from investors.
• Offer for Sale (OFS): Existing shareholders, such as promoters or the government, sell their shares to the public. In this case, the company does not receive the money; the selling shareholders do. Sometimes, an IPO includes both fresh issue and offer for sale.

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Process of an Initial Public Offering (IPO)

The company first appoints merchant bankers or investment banks to manage the Initial Public Offering (IPO). It then prepares a detailed document called the Draft Red Herring Prospectus (DRHP) and submits it to the Securities and Exchange Board of India (SEBI). This document contains information about the company’s financial position, risks, objectives of raising funds, and other important details.

After SEBI reviews and approves the document, the company decides the price of shares. The shares are then offered to the public for subscription. Once investors apply and shares are allotted, the company gets listed on the stock exchange and trading begins.

How is an Initial Public Offering (IPO) Priced?

In India, most IPOs are priced through a method called book building. In this system, the company announces a price band, which means a lower and upper limit within which investors can bid. During the subscription period, investors place bids stating how many shares they want and at what price within that range. After the bidding closes, the final price known as the cut-off price is decided based on demand. The price at which maximum shares can be sold becomes the issue price. This process is called price discovery because the market demand helps determine the fair price.

In some cases, companies use the fixed price method. Here, the company decides the price in advance and investors apply at that specific price. There is no bidding process. However, this method is less common today.

The pricing decision is made by the company in consultation with its merchant bankers after studying financial performance, profitability, industry conditions, growth potential, and investor interest. The Securities and Exchange Board of India (SEBI) does not decide the price of the IPO. Its role is to ensure transparency, proper disclosure, and investor protection under the SEBI (ICDR) Regulations, 2018.

Who Can Invest in an IPO?

Any person above 18 years of age can invest in an IPO, provided they have a PAN card, a demat account, and a bank account linked to the application system. IPOs are open not only to individuals but also to institutions and companies.

Investors are divided into three main categories:

• Qualified Institutional Buyers (QIBs): These include mutual funds, banks, insurance companies, pension funds, and Foreign Portfolio Investors. They invest large amounts and are considered financially experienced.
• Retail Individual Investors (RIIs): Individual investors who apply for shares worth up to ₹2 lakh fall under this category.
• High Net Worth Individuals (HNIs): Investors who apply for more than ₹2 lakh are placed in this category.

Eligibility for Initial Public Offering (IPO)

To protect investors, the Securities and Exchange Board of India (SEBI) has fixed certain financial conditions.

• Financial Track Record: Generally, a company should have:
  • Minimum ₹3 crore net tangible assets in each of the last 3 years.
  • At least ₹1 crore net worth in each of the last 3 years.
  • Average pre-tax profit of ₹15 crore in at least 3 out of the last 5 years.

This ensures that the company has some financial stability and is not a risky or shell company.

• Clean Record: The company, its promoters, and directors should not be involved in fraud or serious legal violations. SEBI checks the background to protect investors.
• Alternative Route for New-Age Companies: Some startups or technology companies may not have long profit records but have strong growth potential. SEBI allows them to list under special provisions, provided they meet disclosure norms and investor protection requirements.

These eligibility conditions ensure that only reasonably stable and transparent companies raise money from the public. The aim is to reduce the risk for small investors.

Legal and Regulatory Framework for Initial Public Offering (IPO)

Initial Public Offering (IPO) in India are governed by several laws and regulations.

• The SEBI Act, 1992 gives powers to SEBI to regulate capital markets.
• The Companies Act, 2013 lays down rules related to company formation, prospectus, and disclosures.
• The SEBI (ICDR) Regulations, 2018 provide detailed guidelines on IPO eligibility, pricing, and disclosure requirements.
• The Securities Contracts (Regulation) Act, 1956 regulates listing and trading of securities on stock exchanges.
• The SEBI (LODR) Regulations, 2015 ensure that listed companies follow corporate governance and continuous disclosure norms.

Initial Public Offering (IPO) Significance

Initial Public Offering (IPO) is significant because: 

• Capital Formation: IPOs help companies raise large funds for expansion, innovation, and infrastructure, which supports overall economic growth.
• Deepening of Capital Markets: More listed companies increase market size, liquidity, and investor participation. This strengthens India’s financial system.
• Encouragement to Entrepreneurship: A successful IPO motivates startups and innovators because it provides a clear path to raise funds and reward early investors.
• Wealth Creation for Public: Common investors get an opportunity to invest in growing companies and participate in wealth creation.
• Improved Corporate Governance: Listed companies must follow strict disclosure and transparency norms under the Securities and Exchange Board of India (SEBI), leading to better accountability.
• Support to Government Disinvestment: IPOs of public sector enterprises help the government raise revenue and reduce fiscal pressure without increasing taxes.

Challenges and Risks of Initial Public Offering (IPO) 

Risks associated with Initial Public Offering (IPO) are as follows: 

• Market Volatility: Share prices can fluctuate due to market conditions, causing losses to investors after listing.
• Overvaluation Risk: Sometimes companies are priced too high, and their performance may not justify the valuation.
• Information Gap: Retail investors may not fully understand business risks or financial details.
• Short-Term Pressure: Public companies face pressure to show quarterly profits, which may affect long-term decision-making.
• Dilution of Control: Promoters lose some ownership and decision-making control after shares are sold to the public.