What is an IPO, in plain words

What is an IPO and why do companies list?

An IPO, or Initial Public Offering, is the first time a company offers its shares to the public. After the IPO, the shares are listed on a stock exchange such as NSE or BSE, where anyone with a trading account can buy and sell them.

Before an IPO, a company is owned by a small group: its founders, their families, early staff and early investors. To sell a part, they have to find a buyer privately. An IPO opens the company to everyone.

Companies list for two main reasons, and an IPO can do either or both:

• Fresh issue. The company creates new shares and sells them. The money goes to the company, for example to build plants, repay loans or grow.
• Offer for sale. Existing shareholders sell some of their shares to the public. The money goes to those sellers, not to the company.

The offer document tells you how much of the IPO is a fresh issue and how much is an offer for sale. That split is worth reading, because it tells you where your money ends up. Listing also brings duties: the company must publish results, disclose important events and follow SEBI's rules. For the bigger picture, read stock market basics for beginners.

What are the DRHP and the RHP?

The DRHP (Draft Red Herring Prospectus) is the first detailed document a company files with SEBI before an IPO. The RHP (Red Herring Prospectus) is the updated version used when the IPO actually opens. Both explain the business, its finances, its risks and the terms of the offer.

The process runs roughly in this order:

1. The company appoints merchant bankers, who prepare the DRHP and file it with SEBI and the exchanges.
2. The DRHP is made public so that anyone can read it and comment. SEBI reviews it and may ask for changes.
3. After SEBI's observations, the company files the RHP. The RHP has nearly everything, but the final price is not yet fixed. That missing detail is why it is called a "red herring" prospectus.
4. After the IPO closes and the price is fixed, a final prospectus is filed.

The most useful part for a beginner is the "Risk Factors" section, near the start. It lists, in the company's own words, what could go wrong. It is long, but it is the company telling you the downside directly. SEBI's review of the document is not an approval of the company or of the price.

What are the price band, lot size and retail category?

The price band is the range within which you can bid for each share. The lot size is the minimum number of shares you must apply for, and you apply in multiples of it. The retail category is the part of the IPO set aside for individuals applying for up to Rs 2 lakh.

• Price band. Most IPOs in India are "book built". The company announces a band, for example Rs 95 to Rs 100. Investors bid at any price inside it. The final issue price is decided after the IPO closes, based on the bids.
• Cut-off price. Retail investors can choose "cut-off", which means "I will pay whatever final price is fixed". Your money is blocked at the upper end of the band so that you are covered.
• Lot size. Also called the minimum bid. If the lot is 150 shares, you can apply for 150, 300, 450 and so on, but not 200.
• Investor categories. Each IPO splits its shares into categories: qualified institutional buyers (large institutions such as mutual funds), non-institutional investors (larger individual and corporate bids), and retail individual investors. For a company that meets SEBI's profit track record tests, at least 35 percent of the net offer must go to retail investors. For a company that does not, retail gets at most 10 percent and institutions get at least 75 percent. The exact split for each IPO is in its RHP.
• The Rs 2 lakh line. Under SEBI's rules, a retail individual investor is one who applies for shares worth up to Rs 2 lakh in an IPO. Above that, you are in the non-institutional category.

You also need a PAN, completed KYC and a demat account to receive shares. See demat account explained if you do not have one yet.

How do you apply for an IPO in India?

You apply through ASBA, which means your money stays in your bank account and is only blocked, not taken, until allotment. You can apply through your stockbroker's app using a UPI mandate, or directly through your bank's net banking.

ASBA stands for Application Supported by Blocked Amount. It is mandatory for IPO applications in India. Here is how it works in practice:

1. Choose the IPO in your broker's app, or in the IPO section of your bank's net banking.
2. Enter your bid: the number of lots and a price inside the band, or tick cut-off.
3. If you use UPI (through a broker), enter your UPI ID. You will get a mandate request in your UPI app. You must approve it within the time allowed, or your application does not count. Approving it blocks the amount in your bank account.
4. If you use net banking, the bank blocks the amount directly from your account.
5. Wait. The IPO stays open for a few working days. You can usually change or cancel your bid while it is open.

The blocked money still sits in your account, but you cannot spend it until the result. Make only one application per PAN for the same IPO. Offer documents say that several applications under one PAN can be rejected, and applying in different names is an offence under company law.

How does allotment work when an IPO is oversubscribed?

When retail investors apply for more shares than the retail category has, the IPO is oversubscribed. SEBI's rules then aim to give the minimum lot to as many retail applicants as possible, and who gets a lot is decided by a lottery (a draw).

"Subscribed 10 times" means applications came in for 10 times the shares on offer in that category. In the retail category, the rule is roughly this: shares are not split pro rata (in proportion to how much each person applied for). Instead, each winner gets one minimum lot. If there are more applicants than lots, a lottery picks who gets one. If some shares remain after every applicant has one lot, the rest are shared out in proportion.

This has a practical meaning. In a heavily oversubscribed IPO, applying for 13 lots does not give you a better chance than applying for 1 lot, because each applicant can win at most one lot in the lottery stage. Your extra money is simply blocked and then released.

The registrar to the issue, a firm appointed to handle applications, works out the allotment, and the stock exchange approves it. You can check your status on the registrar's website, or on the NSE and BSE websites, using your PAN or application number.

Refunds, listing day and the T+3 timeline

In India, an IPO must list on the stock exchange within three working days after it closes, called T+3. If you do not get shares, your blocked money is released by the second working day after closing.

SEBI cut the listing time from six working days to three. The T+3 timeline became mandatory for public issues opening on or after 1 December 2023. If "T" is the day the IPO closes:

If you get shares, only the amount for the shares allotted is debited. Any extra blocked amount is released. On listing day, a special pre-open session finds the first price from the orders of buyers and sellers. That first price can be above, equal to or below the issue price. Nobody fixes it, and nobody can promise it.

What is the grey market premium (GMP)?

The grey market premium is an unofficial number, quoted in informal circles, for what some people say they would pay for IPO shares before listing. It is not regulated by SEBI, is not run by any exchange, and has no legal protection. Treat it as rumour, not information.

You will see "GMP" numbers on websites and in chat groups during almost every IPO. Here is what you should know plainly:

• There is no official grey market. Deals in it happen outside the exchanges, with no record, no clearing and no one to complain to if the other side does not pay.
• Nobody checks the numbers. Anyone can post a GMP, and there is no way to see whether any real trade happened at that number.
• GMP can change quickly, and the listing price can be very different from it.
• If someone offers to buy or sell IPO shares or "application slots" before listing, that deal happens outside the regulated market, so the protections of the exchanges and SEBI's rules for trading do not cover it.

The only official numbers during an IPO are the price band, the subscription figures published by the exchanges, and, after listing, the prices on NSE and BSE.

A worked example: the ABC Limited IPO

Here is a made-up IPO with every number worked out: the cost of one lot, the most a retail investor can apply for, how oversubscription turns into lottery odds, and what listing day could mean in rupees.

ABC Limited is not a real company, and none of these numbers describe a real IPO.

Step 1: the terms. Price band Rs 95 to Rs 100. Lot size 150 shares. Total issue Rs 600 crore, with 35 percent reserved for retail.

Step 2: cost of one lot. At the upper end, 150 times Rs 100 = Rs 15,000. If you choose cut-off, Rs 15,000 is blocked in your bank account.

Step 3: the most a retail investor can apply for. Rs 2,00,000 / Rs 15,000 = 13.33. You can only apply in whole lots, so 13 lots. That is 13 times 150 = 1,950 shares, costing 1,950 times Rs 100 = Rs 1,95,000.

Step 4: shares in the retail category. 35 percent of Rs 600 crore = Rs 210 crore. At Rs 100 a share, that is 2.1 crore shares. Divided into lots of 150, that is 2,10,00,000 / 150 = 1,40,000 lots.

Step 5: oversubscription. Suppose 7,00,000 retail investors apply, and together they bid for 14,00,000 lots. The retail category is subscribed 14,00,000 / 1,40,000 = 10 times.

Step 6: the lottery. There are 1,40,000 lots for 7,00,000 applicants. Each winner gets one lot. So 1,40,000 / 7,00,000 = 1 in 5 applicants, or 20 percent, get a lot. The other 80 percent get none, and their money is unblocked by T+2.

Step 7: if you are allotted. The final price is fixed at Rs 100. Rs 15,000 is debited, and 150 shares reach your demat account by T+2. If you had applied for 13 lots, you would still get one lot, and the other Rs 1,80,000 would be released.

Step 8: listing day. If the first trading price is Rs 110, your 150 shares are worth 150 times 110 = Rs 16,500, which is Rs 1,500 above what you paid, before charges and taxes. If it is Rs 92, they are worth Rs 13,800, which is Rs 1,200 below. Both are possible. A listing price is not promised, and it can fall further after listing.

Common mix-ups

These are the IPO ideas beginners most often get wrong, each with a correction.

1. "Applying for more lots raises my chances in the lottery." In a heavily oversubscribed retail category, no. Each winner gets one minimum lot.
2. "My money is taken when I apply." No. With ASBA it is only blocked. It is debited only for shares you actually receive.
3. "Oversubscription means the shares will list higher." No. High demand during the IPO says nothing certain about the listing price.
4. "SEBI approved the IPO, so it is a good company." No. SEBI checks that the documents follow its rules. It does not judge the business or the price.
5. "GMP tells me the listing price." No. GMP is unofficial, unregulated and unchecked.

Check yourself and where to check

Try these three questions, then use the official websites listed below to look up any real IPO's documents and status.

1. A price band is Rs 190 to Rs 200 and the lot is 75 shares. How much is blocked for one lot at cut-off?
   Answer: 75 times Rs 200 = Rs 15,000.
2. The IPO closes on a Monday and there are no holidays that week. On which day should it list under T+3?
   Answer: Thursday. Monday is T, Tuesday is T+1, Wednesday is T+2, Thursday is T+3.
3. Who runs the grey market?
   Answer: Nobody official. It is not regulated by SEBI or run by any exchange.

• SEBI: draft offer documents (DRHPs) filed for public comment, and the rules for public issues.
• SEBI investor website: free guides on how IPOs and ASBA work.
• National Stock Exchange (NSE): current IPOs, subscription figures and allotment status.
• BSE: current IPOs, subscription figures and allotment status.

After listing, an IPO share trades like any other. To understand what moves it from then on, read why share prices change, and for the words used here, the stock market terms glossary.