IPOs: how they work, and why caution beats excitement

What an IPO actually is

IPO stands for initial public offering. A private company offers its shares to the public for the first time and becomes listed on an exchange, after which anyone can buy and sell them.

The money can go to two different places, and the distinction is genuinely important.

• A fresh issue creates new shares and the money goes into the company, to repay debt, build capacity or fund growth. You are funding the business.
• An offer for sale means existing owners are selling their shares. The money goes to them, not to the company. You are buying someone out.

Most IPOs are a mix, and the split is disclosed in the offer document. An IPO that is almost entirely an offer for sale tells you the main purpose was to let early investors exit, which is legitimate and is a different proposition from funding growth.

How to apply

You need a demat account and a linked bank account. The process is entirely online.

• A price band is announced, for example ₹280 to ₹295. You bid within it, and most retail investors bid at the top, called the cut-off price, to maximise their chance of allotment.
• You bid in lots, not single shares. A lot is a fixed number of shares, sized so a single lot is roughly ₹15,000, and you can apply for whole lots only.
• Money is blocked, not taken. Through ASBA or a UPI mandate, the amount is frozen in your bank account. If you receive no allotment it is simply released. You continue earning interest on it while blocked.
• The issue is open for a few days. Applications close, allotment is finalised, and unallotted amounts are released.
• Listing follows shortly after allotment, within the timeline SEBI prescribes.

One person can apply once per PAN in the retail category. Applying multiple times from the same PAN gets all applications rejected. Families sometimes apply through several members legitimately, using each person own PAN, demat account and funds.

How allotment is decided

The offer is divided between categories: qualified institutional buyers, non-institutional investors, and retail individual investors, with a portion reserved for retail.

If the retail portion is oversubscribed, which is common for anticipated issues, allotment is done by a computerised lottery. Applying for ten lots does not improve your odds proportionally in the retail category, because everyone is treated on a per-application basis for the minimum lot.

The practical consequence: for a heavily subscribed IPO, applying for one lot from each eligible family member gives a better chance than applying for many lots yourself. This is legitimate, and each application must genuinely use that person own PAN, demat account and money.

It also means IPO investing is unreliable as a strategy. You often cannot get shares in the issues you want, and you can get plenty in the ones nobody wanted.

The structural problem worth understanding

This is the part most IPO coverage skips, and it should shape how you think about every issue.

The people selling know the business better than anyone. They choose the timing and they influence the price, with bankers hired to achieve the best outcome for them. Companies overwhelmingly list when sentiment is strong and valuations are generous, because that is when they raise the most.

That does not make IPOs a trap. It means the information and timing advantage sits firmly with the seller, and you should require a stronger case than usual rather than a weaker one.

You also have less to work with. A listed company has years of quarterly results and annual reports you can read. An IPO has one offer document, prepared by the company, describing a track record you cannot check against how the business behaves under public scrutiny.

Listing gains, described accurately

Most people applying for IPOs are hoping to sell on the first day at a higher price. It works often enough to be attractive and it is not a rule.

In strong markets, a majority of issues list above their price and the strategy appears reliable. In weaker markets, a substantial share list below the issue price, and investors who applied expecting a quick gain hold something they never analysed and did not want.

You will also see references to a grey market premium, an unofficial indication of what shares are trading for before listing. It is unregulated, easily manipulated, and not a reliable guide. Treating it as information is a mistake.

A tax point too. Selling on listing day is a short term gain, taxed at 20% with no exemption, against 12.5% above ₹1.25 lakh for holdings beyond twelve months. Listing gains are taxed at the higher rate.

A sensible approach

IPOs are not a category to avoid or to chase. They are ordinary companies being sold at a moment chosen by the seller.

• Decide before applying whether you want to own this business. If the answer is only "for the listing pop", you are speculating, which is allowed, but be honest that that is what it is.
• Check the fresh issue versus offer for sale split. Is this funding a business, or funding an exit?
• Read the risk factors. Ten minutes, and often the most informative part.
• Check what the money is for. Repaying debt is very different from building capacity.
• Ignore the grey market premium. It is unregulated and frequently misleading.
• Never borrow to apply. People have taken loans to fund IPO applications on the assumption of a listing gain. When it does not arrive, the loan does not care.
• Waiting is free. Nothing prevents you buying the company six months after listing, once there is a quarter or two of results as a listed entity to judge it by.

That last point is worth more than it sounds. There is no rule that says you have to buy on day one, and by waiting you replace a promotional document with actual evidence.