When a company sells its shares to the public for the first time, who picks the day, the price and the mood of the market? The seller does. Here is what decades of data show, and ten questions to ask first.
Ravi: "Everyone in my office is applying for the new IPO. Listing gain is sure, no?"
Meera: "Who is selling, and why today?"
Ravi: "The company, I think."
Meera: "Check. Sometimes the company gets the money. Sometimes the old owners take it home."
Ravi opens the offer document for the first time. It runs to hundreds of pages.
Meera: "You don't need every page. You need ten answers."
The idea in one line
An IPO (initial public offering, a company's first sale of shares to the public) is a sale, and in every sale the seller picks the time and the price. The buyer's only edge is asking the right questions.
How an IPO works
Company and its bankers set a price band (the lowest and highest price) → big institutions called anchor investors buy a day early → the public window stays open for about three days → if bids are more than the shares on offer, the issue is oversubscribed → small applicants get shares by lottery → listing day → lock-ins end and more shares can be sold.
Every IPO has two possible parts. Know which one you are buying.
| Part | New shares? | Money goes to | Used for |
|---|
| Fresh issue | Yes | The company | Growth, repaying loans, general purposes |
| Offer for sale | No | The old owners | Their own pocket |
In India, "general corporate purposes" can be at most 25% of the money raised, and anyone holding more than 20% of a company can sell at most half of that holding through an offer for sale.
Ten questions before you join an IPO
1. Why now? IPOs bunch up when the market and the sector are high. The seller picks the moment that is best for the seller.
2. Where does the money go? Fresh issue for growth or for repaying loans tells one story. A big offer for sale tells another.
3. Who is selling, and at what price did they buy? A large gap means a large part of the gain has already gone to them.
4. Does the business make money, and cash? Read three to five years of sales, profit and cash from operations. Profit without cash is a warning sign.
5. Is it the first of its kind, or the fifth in a hot theme? A pioneer can build a new field. A late follower often arrives when excitement is at its peak.
6. How is it priced against listed rivals? Compare the price-to-earnings (P/E) ratio with companies already listed. If no listed rival exists, you are paying for a story.
7. Who runs it? Look at the promoter's stake after the IPO, any shares pledged against loans, court cases and deals with related companies.
8. What do the risk factors say? It is the section most people skip, and the company is required to write it.
9. Who else is buying? Demand from big institutions is the most informed signal. Anchor investors are locked in: half of their shares for 30 days, the other half for 90 days.
10. What is your own reason? A listing-day gain and a ten-year holding are different decisions, with different checks.
What history shows
A study of 9,253 US IPOs over 45 years found an average first-day gain of about 19%. Over the next three years, the average IPO trailed the overall market by about 20 percentage points, and smaller issues trailed by more.
An earlier US study found that companies going public returned about 5% a year over the five years after listing. To end up as rich as with similar companies that did not issue shares, an investor needed 44% more money.
In India, a study of 92 IPOs measured against the Nifty found that buyers on listing day trailed the index for the first 12 months.
In one Indian boom year, about 100 companies listed. Years later, about a third had stopped trading (this count includes mergers and buyouts, not only failures), about a fifth were down 80% or more from their issue price, and 15 had beaten the Nifty. In a smaller boom year, of 64 IPOs, 26% had stopped trading and 28% were down 80% or more.
SEBI's own study of 144 IPOs found that about half of the shares given to investors, by value, were sold within a week of listing. When the first-week gain was above 20%, individual investors sold 68% of their shares in that week.
A US study of lock-in endings found prices slipped about 1.5% over three days and trading volume rose 40% for good.
After listing: the check almost nobody does
A monitoring agency tracks how the IPO money is spent until all of it is used, and its reports are public. Compare what was promised in the offer document with what was actually spent.
You learned
An IPO is a sale. The seller chooses the time and the price.
A fresh issue feeds the company. An offer for sale feeds the old owners.
In the data, the first year after listing has been the weakest stretch for those who bought on listing day.
Words in this piece
IPO: a company's first sale of shares to the public.
Price band: the lowest and highest price at which you can bid.
Anchor investor: a big institution that buys a day before the public window opens.
Lock-in: a period in which some holders cannot sell.
Oversubscribed: more shares asked for than are on offer.
Fresh issue: new shares; the money goes to the company.
Offer for sale: existing owners sell; the money goes to them.
Offer document: the company's official book of facts and risks for the IPO.
P/E ratio: share price divided by profit per share; how many years of profit you pay for.
Monitoring agency: an outside body that reports how IPO money is used.
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