New Delhi: India’s initial public offering (IPO) market has been quite active in recent times as companies turning to public investors to raise capital and expand their businesses. Joining the trend is Reliance Industries’ Jio Platforms Ltd (JPL), which is set to make its debut on the Indian stock market with an IPO expected to be the country’s largest ever, valued at $3.2 billion.

While IPOs allow companies to enter the stock market and raise capital from public investors, they also offer first-time investors an opportunity to buy shares in a company when it first opens its ownership to the public. However, investing in an IPO requires an understanding of how the process works, how shares are priced and what risks investors should consider. For those planning to invest in an IPO for the first time, understanding the basics is essential. Here is a guide to what an IPO is, why companies launch public offerings and how investors can participate.

The capital market is an essential component of a nation's financial system. It is categorized into two broad segments: the Primary Market and the Secondary Market. These are mutually dependent and must exist in order to raise capital. While companies make use of the primary market to raise new capital directly from shareholders, the secondary market provides a platform for frequent exchange of such securities, so that investors have liquidity and investor confidence is maintained.

One of the most important ways a company raises funds in the primary market is by making an Initial Public Offering (IPO). This is the initial time at which a company sells its shares to the general public and gets listed on a stock exchange. The money raised from an IPO is called company's ‘Share Capital’, offering partial ownership of the firm to the public. With the help of IPO, companies are able to collect a substantial amount of money with a long or indefinite maturity, which can be utilised to drive growth, innovation, and expansion.

Why Do Companies Go Public?

An IPO is very significant for any company. Before going public, firms generally have limited funds from private investors, promoters, or venture capitalists. But as the business grows, it might require substantial capital to expand operations, enter new markets, or develop infrastructure.

By means of an IPO, a business obtains public capital markets to raise the funds. Apart from ensuring stability in finances, this also improves the visibility and credibility of the business. A listed company usually experiences more trust from investors, lenders, and even clients. The firms also get access to substantial capital through follow-on public offerings.

Also, if a company witnesses record IPO launches, it is a sign of a healthy economy. It indicates investor confidence and a positive attitude towards economic and business growth.

How Do IPOs Work?

When a company plans to become a listed company, it releases a prospectus, which has the details of its financials, business model, risks, and also informs the plan what it intends todo with the raised funds. Interested investors subscribe to the IPO within a defined window. When the IPO succeeds, the company gets the funds, and its shares are traded on stock exchanges for the general public.

Significantly, in an IPO, the nexus is direct between the company and the investors. The funds raised go directly to the company, and the company uses them to invest in fixed assets or working capital. Once the IPO is over, the shares can freely be bought and sold in the secondary market, allowing the shareholders to be able to exit their investment at any time.

Book Building vs. Fixed Price Issue

There are two main ways of offering an IPO: Book Building and Fixed Price Issue.

Book Building is a flexible and commonly used pricing technique. As per SEBI (Securities and Exchange Board of India), it is a method to find the price of securities by gathering bids from investors during the IPO window. Bids are made in a price band higher or equivalent to the price floor, and the last offered price is determined on the basis of such bids. Book building has one significant benefit in the sense that day-by-day demand can be followed, making for effective price determination.

A Fixed Price Issue, on the other hand, fixes a predetermined price for the securities. Investors are aware of the price at the time of application, but the demand for the shares is known only after the issue is closed.

An IPO is a valuable weapon for companies as well as investors. It assists companies in raising substantial funds to grow, while providing investors with a chance to own part of potentially high-growth opportunities.