Things to Check before Investing in an IPO

The stock market offers investors ample opportunities to grow their capital and earn high profits. An IPO (Initial Public Offering) is a unique investment opportunity where investors can be the first to own the shares of an emerging company. They can use this chance to make a quick listing gain or hold their shares to benefit from the company’s long-term growth.

However, like all investments, you need to understand the concept of IPO and all other things that affect its value before investing in it. Keep reading to know all about making an informed choice on an IPO investment.

What Is an IPO?

An Initial Public Offering is a process where a private company lists itself as a public company to raise capital from the public by offering its shares.

It is the first offering of a company’s ownership to external investors in the primary market. Investors who are looking to invest in newly listed companies buy shares issued at an IPO so that they can sell them at some point in the secondary market for profits. A company launching its IPO can be an old as well as a new entity. Some companies launch IPOs even after 20-30 years of private existence as well.

As a private company, the shareholders are limited to founding members, directors, employees, and private investors. Such companies cannot raise funds by selling shares to other investors. An IPO allows them to get capital without incurring any liabilities for various purposes, including expansion, R&D, debt payments, and increasing production facilities.

How Does an IPO Work?

When a company decides to go public, it has to launch a public offering by allotting its new shares at an issue price to interested public investors in the primary market. Companies announce their IPO listing and a price band followed by a bidding date.

To issue its shares to the public, a company must abide by strict regulations set by the Securities and Exchange Board of India (SEBI). To get approval from SEBI, companies must file draft papers containing all information about the company’s financials and the public issue.

On the bidding day, investors bid for shares by selecting a price they are willing to pay for at least one lot of IPO shares. Then, based on the number of shares available, market demand, and correctness of their applications, shares are allotted to final investors.

You cannot buy one share in case of an IPO like in the secondary market. An IPO is sold in lots consisting of a certain number of shares. Each lot has an equal number of shares; it is the minimum you must buy to get an IPO allotment.

 The price at which an IPO is offered to investors is called as offer price. An IPO’s issue price and face value may or may not be the same. Based on the demand in the market and several other factors, companies set a premium or discount value on their IPO. This discount or premium is added or subtracted from the face value to determine the issue price of an IPO.

A fixed number of shares are offered in an IPO; thus, if the demand for allotment of shares is more than the total shares, the company is unable to allot shares to all investors. This situation is called an oversubscription. Similarly, when the total subscriptions applied are fewer than the total number of shares, it is called under subscription.

What Are the Essential Factors to Consider before Investing in an IPO?

As applying for an IPO allotment is an important financial step, you need to carefully consider its merits and demerits before you subscribe. Primarily you should carefully research the company, its business, and its other fundamentals. Secondly, you should evaluate if the investment is worth the risks.

Keep reading all the points below to learn the things you should consider for investing in an IPO.

• Check for the Reputation of Underwriters

Underwriters are financial experts who market, manage and sell the IPO on behalf of a company in exchange for a profit. Reputed underwriters do not associate with companies that may not have a successful stock life cycle. Brokers conduct extensive research before getting on board with any company. Hence, you can make your task easy by simply researching the underwriters and not just the company.

• Study the Prospectus

All companies prepare a prospectus known as Draft Red Herring Prospectus (DRHP) as a compulsory guideline by SEBI. To get all information about the company in one place, study the DRHP it has filed with SEBI. 

From the prospectus, you can view the company’s balance sheet, expenses, risks, legal proceedings, the purpose of its IPO, and future opportunities and plans. It is one of the best places to research a company’s fundamentals.

• Identify the Reason for Raising Funds

Companies primarily launch an IPO to collect funds for some business activity or to manage financial responsibilities. Identify the reason for the IPO of a company and evaluate if it will benefit their business and, in turn, your investment returns. 

Companies that collect funds only to pay off loans and manage various hurdles may not be safe investments.

• Understanding Company Promoters and Management

A company’s promoters and management are a reflection of its potential. Analyze the quality of its management and promoters and their past accomplishments, etc. This will help you to determine if they will be a relevant business in the long term. Quality management and promoters can uplift a company to an exceptional extent.

• Analyse the Business

It is very crucial to study the business performance of a company to understand if it is a worthwhile investment opportunity for you. Analyze its 5-10 years annual performance and initiatives. Learn about the company’s plans, undertakings, loans, etc.

• Competition in Market

Competition is very important to the future of a business. Based on the sector the company operates in determines the scale of competition in the market. Also, determine the position of the company among its competitors.

• Net Worth of a Company

Always evaluate the net worth of the company to understand if its shares are undervalued or overvalued and how it impacts your investment. This will also help you  to determine the company’s market capitalization when it is listed.

• Identify the Business Sector

First, identify the industry or sector in which a business operates. You should not invest in a sector you do not know much about. Make sure you are familiar with the sector and its performance collectively. Positively study the performance of the entire sector and analyze its future prospects.

• Do a SWOT Analysis

The Strengths, Weaknesses, Opportunities, and Threats (SWOT) of a company are major indicators of its quality of business and how successful it is and will be. Hence, you should identify these four components of a company and determine its business quality accordingly.

• Brand Recognition

Understanding how popular  a company is, is an essential factor in determining the market demand for its shares and the share price. It determines how much acceptance and popularity the shares will have when it launches in the market. However, brand recognition does not affect all businesses equally.

Eligibility Criteria for Investing in an IPO

The IPO process is completely regulated by the SEBI, a government body dedicated to regulating the capital markets in India. It ensures the safety and fair practice norms for all trades in the share market. 

To apply for an IPO in India, you need to fulfil several eligibility criteria as per the guidelines of SEBI.

• Age Limit

You should be above the age of 18 years to successfully apply for an IPO in India.

• Demat Account

You need to have a Dematerialised (Demat) account registered with your PAN number with either of the two Indian depositories, National Securities Depository Limited (NSDL) and Central Depository Services (India) Limited (CDSL). A Demat account is a virtual deposit account that stores your financial assets. 

• Trading Account

Along with a Demat account, you also need to have a trading account registered to your PAN to sell shares you obtain from the IPO. You can choose to get your trading account from any reputed online brokers in India.

• Bank Account

Another important criterion is to have an active bank account in your name to invest in an IPO in India. It is best if your bank account has internet banking enabled to support Application Supported by Blocked Amount (ASBA). 

In addition, you should have an active phone number and email ID linked with your bank and a working UPI number. It will make your investment experience hassle-free.

• SEBI Verified Investor Category

You should fall under the allowed category of public investors for IPO as per SEBI. The allowed categories are Institutional Buyers, Non-Institutional Buyers, Employees, and Individual investors.

Final Word

Investing in an IPO can offer good returns if you plan your investment and exit strategy well. A well-performing company generally provides good returns to its investors in the long run. 

However, you must consider all the above points before subscribing to an IPO. As an investor, you should thoroughly research the company and determine your investment horizon to ensure a profitable investment.

Frequently Asked Questions