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What Are IPOs? What You Should Take Care Before Investing Into One?

by Shatakshi Gupta

Nowadays, the Indian stock market is flooded with IPOs. One gets the opportunity to invest in an IPO every other day. Stock indices are trading at their all-time highs these days. Seeing the market trend, more IPOs are expected to appear on the market. IPOs offer very good returns even on their listing day itself, although new investors need to keep some things in mind before investing in these IPOs. It is important to note that not all IPOs get the success they want. There have been many IPOs in the past that did not succeed while many others performed very well and grew the wealth of the investors.  While investing money in IPO, it is important for investors to keep some things in mind, which we have told here. New investors need to be wary of a few things before investing in an IPO. Before discussing the indicators that one should see, let’s us understand what is an IPO?

What is an IPO?

An IPO or Initial Public Offer is made by a company to raise capital from the market. It is the process of converting a private company into a public company. A public company means a company whose shares are held by people. When companies need money, they list themselves in the stock market and dilute their shares. The company spends the capital received through IPO according to its need. This fund can be used to pay off debt or for the growth of the company etc.

What is the process of releasing an IPO?

The shares that are allotted in an IPO are usually listed on a stock exchange like BSE or NSE. On these exchanges, people can buy and sell these shares.

 If a company decides to float an IPO, then it has to follow certain rules and guidelines of the market regulator SEBI. To meet all these rules, the company appoints a merchant banker or an underwriter, this banker is registered with SEBI. 

When a company brings IPO, it submits some documents while applying to SEBI. It is also known by the name Draft Red Herring Prospectus (DRHP). The DRHP of any company’s IPO actually gives information about that company, its shareholders, its financial condition, the functioning of the company, its legal problems, debt on it, the use of the money received from the IPO, the risks associated with it, etc.

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 SEBI does its assessment and if everything is found right then only the company is allowed to bring IPO. After getting approval from SEBI to bring IPO, the company invites bids for its shares. In this, different share reserves are kept for different types of investors such as retail, institutional. Generally, the IPO of any company opens for three days.

Things to keep in mind:

 Go through DRHP thoroughly:

A Draft Red Herring Prospectus or DRHP of a company reflects its financial position. This document is presented to the market regulator SEBI, which contains important information related to the company. You should read it thoroughly before deciding to invest. DRHP provides much important information, with the help of which you can understand the business of the company better and take investment decisions based on this.

Understand the objective of capital raised:

It must be taken into account where the funds raised by the company are to be used. If the company is burdened with debt and mentions in the DRHP that the proceeds will be used to pay off the existing debt, then investors should be more careful in investing in it.  However, if the fund is to be used for the mixed purpose of growth of the company along with repaying the debt, then the investment can be considered. If the company is already performing well and wants to use the funds received from the IPO for the growth of the company, then investing in it can prove to be a profitable deal.

Knowing about the promoters of the company:

One should check the proprietorship and management of the company. This includes the promoters of the firm and other key management executives. Whether the company will grow or not depends largely on who are its promoters and key executives. All business decisions of the company are taken by them. An investor should take into account the number of years the key management executives have spent with the company.

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Know about future plans:

Factors such as the company’s position, market share, reach of its products, geographical spread, expansion plans, projected profits, supply chain, crisis handling capacity, etc., need to be taken into account in the sector the company belongs to. Based on all these variables, it can be estimated whether the company will grow in future or not.

Calculate the associated risk:

The company mentions about the risk factors in its DRHP. An investor should read it carefully. These are the things that depend on whether investing in this IPO will be profitable or not. There can be a variety of risk factors including legal litigation, policy-related changes and interest rates. This can affect the future growth prospects of the company. Like any other investment, it is important to assess your risk appetite before investing. You should invest according to your risk appetite. If the business looks too risky as advised by the market participants and does not match your risk appetite, it is better to avoid investing in such IPOs.

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