What is an IPO and how does the process work?

If you are feeling lost in the sea of financial news, Business Standard has you covered. Of late, several companies have come out with their IPOs and got listed on stock exchanges.

What is an IPO, you ask? Well, let’s understand all about it with a hypothetical case.

Suppose there is an entrepreneur, Rahul, who wants to start a furniture business.

Rahul starts this business with his own money and some more from friends and family. The money helps him produce some furniture items.

For the next few years, Rahul puts the money that he makes from selling the furniture back into the business. He is able to produce more models, service more customers, and even open a second store.

But Rahul has bigger plans. So, he goes to an investor. The investor invests money in his business in return for equity. In doing so, the investor becomes a shareholder in Rahul’s business.

Rahul’s furniture business has become big, with stores in every metro city. Now he wants to make it a full-fledged chain, and even export his furniture. For this, he decides to tap public markets for money. 

This is where an IPO comes in.

IPO stands for initial public offering. Basically, it is the process of selling a portion of the company to public shareholders like you and me. The company then gets listed on stock exchanges like the NSE or BSE and its shares are traded actively.

It often takes months, even years to successfully complete an IPO. Let’s see how Rahul does it.

Rahul first has to hire investment bankers. These people conduct detailed analyses of the company, audit financials and streamline processes according to the best practices.

They also help Rahul create a draft red-herring prospectus, which is an exhaustive document that tells prospective investors everything about the business.

But wait, for an IPO in India, the company has to be of a certain size. It must be profitable and must have had at least 15 crore rupees in profits in each of the previous three years. The business’ valuation must be at least 10 crore rupees, and the promoters must have at least 3 years of experience of running the business.

The next step is roadshows. Roadshows are basically presentations to large institutional investors to drum up interest. Meanwhile, Rahul has to put in an application with the Securities Exchange Commission of India, which must sign off on the IPO.

Now, Rahul and his investment bankers open the issue on a set date, over a couple of days. This is when institutional investors and the public bid to buy shares in Rahul’s furniture business. Eventually, shares are allotted to qualified bidders. And, boom, the IPO is done.

Rahul’s furniture business is now listed on a stock exchange and active trading in its shares begin.

So, the next time you see an IPO taking place, we hope you will remember Rahul’s story and know exactly how the process would have worked.