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What Is an IPO? Research Team | Posted On Friday, November 27,2009, 07:51 PM

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What Is an IPO?



What is an IPO?

The term IPO stands for Initial Public Offer and it is in practice in the primary market of shares and stocks. It is the first issue of shares of a company to the public. An Initial Public Offering (IPO) is the first sale of stock by a private company to the public. IPOs are often issued by smaller, younger companies seeking capital to expand, but can also be done by large privately-owned companies looking to become publicly traded.

IPOs can be a risky investment. For the individual investor, it is tough to predict what the stock will do on its initial day of trading and in the near future since there is often little historical data with which to analyze the company. Also, most IPOs are of companies going through a transitory growth period, and they are therefore subject to additional uncertainty regarding their future value.

In short we can say that IPO is the medium through which a company raises equity capital from the public. By this process it also gets listed on the stock exchange

Who Decides the IPO Price?

Company with the help of lead managers decides the price or price band of an IPO. Merchant bankers or syndicate members are acting as the lead managers of companies.

Registrars to the Issue

Registrar plays an important role in an IPO process. Their main job involves processing of IPO applications, allocation of shares to the applicants on the guidelines provided by SEBI, processing refunds and also allocating shares in the account of the applicants.

Lead Managers in an IPO

Lead managers are the independent financial institutions which are appointed by the companies generally involving big IPO’s. Their main responsibility is to initiate the IPO process, help the company in road shows, creating draft offer document and also getting the same approved by the SEBI and Stock exchanges and also helping the company in getting its shares listed on the stock exchanges.

What is IPO Cycle?

There are three stages in the life cycle of an IPO Prospectus such as;

  • Draft offer document

  • Offer document

  • Red Herring prospectus

Stage 1:- Draft offer Document

Issuing company and the Book building lead managers prepare the draft offer document which is submitted to SEBI for the review. Now the SEBI may ask the lead managers to either make any changes if required or approve it.  

Stage 2:- Offer Document

Once the Draft offer document gets cleared by SEBI it becomes offer document, offer document is a modified version of Draft offer document after SEBI’s suggestion

Stage 3:- Red Herring Prospectus

Once the offer document gets clearance from SEBI the issuing company adds number of shares and the price on the document which is then offered to the public. The issue prospectus is now called the red herring prospectus.

See Also: Methods of IPO

Life Cycle of an IPO

There are eight major steps in the life cycle of an IPO such as;

  • IPO process initialization

  • Pre Issue Role - Part 1

  • Prospectus Review

  • Pre Issue Role - Part 2

  • Bidding for the public issue

  • Price Fixing

  • Processing IPO Applications

  • Stock Listing

1) IPO Process Initialization - Issuing Company

Lead managers are appointed as book runners

Registrar to the issue are appointed

Syndicate members are appointed

2) Pre Issue Role - Part 1 - Lead Manager's

Draft offer prospectus document for IPO is prepared

Filing of draft offer prospectus with SEBI.

Road shows are conducted

3) Prospectus Review - SEBI

Reviewing draft offer prospectus by SEBI

If any changes are required in the document it is sent back

The draft offer prospectus becomes Offer Prospectus after the approval of SEBI

4) Pre Issue Role - Part 2 - Lead Manager

Submitting the offer documents to SEBI

Decision on the issue date & issue price band is taken

Offer Prospectus modification with respect to date and price band if any. Document is now called Red Herring Prospectus.

Printing and distribution of red herring prospectus and IPO document to syndicate members

5) Bidding for the Public Issue - Investor

Public Issue Open for investors bidding.

Filling of application form by the investor

Providing bidding information to BSE/NSE

Sending the cheques collected to the registrar by syndicate members

Revision of bid by investor if any

Updating stock exchanges with latest data

Closing of public issue

See Also: Factors To Consider Before Investing In An IPO

6) Price Fixing - Lead Manager

Lead managers evaluate the final issue price.

Red Herring Prospectus is updated with the final issue price and sent to SEBI and Stock Exchange

7) Processing IPO Applications - Registrar

All cheques and application forms are received by registrar

Applicant data is feeded into systems

Cheques are sent for clearance.

Looking out for all bogus application

Finalizing the pattern for share allotment

Preparing 'Basis of Allotment'

Transferring shares in the demat account of investors.

Refunding the remaining money though ECS or Cheques

8) Stock Listing - Lead Manager 

After the completion of all the above process lead managers decide the listing date with stock exchanges

Final listing of share on the exchange

Basic Concepts Attached with IPO

  • Fixed issue price

  • Book building issue

  • Floor price

  • Cut off price

Fixed Issue Price

Price at which the securities are offered/ allotted is known in advance to the investor

Book Building Issue

Price at which securities will be offered/ allotted is not known in advance to the investor. Only an indicative price range is known

Floor Price

Floor Price is the minimum price (lower level) at which bids can be made for an IPO.

Cut Off Price

Cut off price refers to the price which is decided by the issuer i.e. the price at which the issuer decides to make the allotment and it indicates that the applicant is ready to accept the price decided by the issuer if he/she mentions cut off prices on the share application form.

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