2.1.15 IPO (Initial Public Offering)

What actually happens in an IPO

Before an IPO, a company is owned privately, often by founders, employees and early investors. The IPO process converts a portion of that private ownership into publicly traded shares, raising fresh capital for the company and giving early investors a way to sell their stake. The listing typically generates significant public attention, which is part of why demand can run well ahead of the company's actual fundamentals.

In India the process is regulated by SEBI and runs through a Draft Red Herring Prospectus that discloses financials, risk factors, use of proceeds and promoter background, with the price set through a book-building process where investors bid within a price band. The prospectus, especially its risk-factors section, is the single most important document to read before applying, and it is routinely skipped in the rush of listing-day excitement.

Why many IPOs disappoint afterward

Companies and their bankers generally aim to price an IPO to generate strong initial demand, which can leave less room for further gains once the shares start trading freely. Combined with the fact that a young public company often lacks the multi-year track record available for an established listed business, this is why data across many markets and years shows the average IPO underperforming the broader market over the following one to three years.

The incentives explain why. The seller, whether the company or its existing investors, naturally wants the highest possible price, and the buyer receives shares at a price set by the seller's bankers rather than through open market discovery over time. Retail investors also get a separate allocation quota, allotted by lottery when an issue is oversubscribed, so the capital blocked during application earns nothing and the probability of allotment in a hot issue can be very low.

A more patient approach

There is nothing wrong with eventually owning a good company that once had an IPO. The more reliable approach is usually to wait for a genuine track record as a public company, several quarters or years of actual results, rather than buying purely on listing-day excitement.

If you do participate, treat an IPO with the same rigour as any other equity investment: understand the business model, compare the valuation to listed peers, and check the use of proceeds. An offer that mainly funds a promoter's exit puts money in existing shareholders' pockets, while a fresh-issue component raises capital for the business itself and is generally more aligned with new investors' interests.