The IPO

A company does not usually open its doors to the public on day one. It grows first on private money: the founders' savings, a few wealthy backers, perhaps some venture investors. For years the owners are a small, closed group. Then, at some point, the company wants to raise a large sum at once, and to let those early backers finally sell part of their stake. So it does something it has never done before. It offers its shares to the general public. That first offering has a name almost everyone has heard and few can define: the IPO.

What an IPO actually is

IPO stands for initial public offering. It is the first time a company sells its shares to the general public. The word initial matters, because this is the debut. Before its IPO a company is private, owned by a small group, and its shares cannot be bought by ordinary investors. After its IPO the company is public, its ownership is open to anyone, and its shares can be traded freely on a stock exchange.

An IPO is a primary-market event, the idea from the last chapter. When the company sells new shares in its IPO, the money raised goes to the company, and sometimes to early shareholders who are selling part of their stake. It is the company raising equity, just from the public at large instead of a handful of private backers.

What happens, step by step

The process looks complicated from outside but follows a clear path.

First, the company decides it is ready and hires investment bankers to manage the sale. Their task is to price the offering and find buyers.

Second, the company prepares and files a detailed document, the offer document or prospectus, with SEBI, the market regulator. It sets out the business, its finances, how it plans to use the money, and, by law, its risks. Anyone can read it, and a careful investor should.

Third, a price is set, usually as a narrow price band rather than a single number. During a short application window, investors apply for the shares they want at that price.

Fourth, the shares are allotted. If more people apply than there are shares, which is common for a sought-after IPO, you may receive fewer than you asked for, or none at all.

Finally comes listing day, the day the shares begin trading on the exchange. From that moment the price is no longer set by the company. It moves freely, up or down, on the demand of buyers and sellers.

Listing day is also the moment the market takes over from the company. In the IPO you bought from the company in the primary market. The instant the shares list, all further buying and selling happens between investors in the secondary market, and the company receives nothing more from those trades.

What to carry forward

An initial public offering is the moment a private company becomes public by selling its shares to ordinary investors for the first time. The money raised in the IPO funds the company, which makes it a primary-market event. The company files a prospectus with SEBI that a serious investor reads, a price is set, shares are allotted, and on listing day the shares begin trading freely on an exchange. From listing day onward, shares change hands between investors, and IPO excitement is never a promise of profit.

That raises the obvious next question. Once shares are listed, where exactly do they trade, and who makes sure the trading is fair? The next chapter introduces the exchanges, the NSE and the BSE, and the regulator that watches over them, SEBI.