How an IPO actually works

Every share you trade on NSE or BSE was, at some point, sold to the public for the very first time. That first sale is the Initial Public Offering, or IPO — the moment a privately-held company opens its ownership to ordinary investors. By the time you read about an IPO in the news it feels like an event, almost a festival, complete with predictions of how much you'll 'make' on day one. Strip the festival away and an IPO is something far more ordinary and far more useful to understand: a business raising money by selling pieces of itself, at a price it and its bankers have negotiated, under rules written by the regulator.

This chapter is about the machine behind that event — who's selling, who's buying, how the price is set, and why the whole thing is structured the way it is. Once you can see the machine, the breathless coverage stops being persuasive, because you understand what the people on the other side of the trade are actually trying to do.

Why a company goes public at all

A private company that wants to grow faster than its own profits allow needs outside money. It can borrow, or it can sell ownership. An IPO is the second door, done at scale and in public. But there's almost always a second motive sitting alongside 'raise money', and it's important to see both clearly, because they pull in different directions.

• Fresh capital for the company — brand-new shares are created and sold, and the cash goes into the business to build plants, repay debt, fund expansion. This part genuinely strengthens the company.
• An exit for early owners — founders, employees and especially early venture investors get a chance to sell some of their existing shares and finally turn years of paper wealth into cash.

In the formal language of an Indian IPO, the first is called a fresh issue and the second an Offer for Sale (OFS). Most IPOs are a mix of both. The distinction matters more than beginners realise: in a fresh issue the company gets the money; in an OFS, not a single rupee reaches the company — it all goes to the selling shareholders. An IPO that is overwhelmingly an OFS is, bluntly, early investors cashing out and inviting you to buy their shares. That isn't automatically bad, but you should know which one you're funding.

The cast of characters

An IPO is not something a company does alone. A whole supporting cast is legally required, and each member has a job and an incentive worth understanding.

• The company (the issuer) — wants to raise money, ideally at the highest price the market will bear.
• Merchant bankers / lead managers — the investment banks that build, price and market the issue. They're paid by the company and want a successful, fully-subscribed offer.
• SEBI, the regulator — does not 'approve' or bless the price. It checks that the company has disclosed everything an investor needs and that the process is fair. SEBI polices disclosure, not whether the IPO is a good deal.
• Registrar — handles the back-office machinery: collecting applications, running the allotment, processing refunds.
• Anchor investors — large institutions invited to buy a chunk a day before the IPO opens, lending credibility and stability.

The DRHP: the document that actually matters

Before an IPO, the company files a Draft Red Herring Prospectus (DRHP) with SEBI — a long, dense document that is, genuinely, the single most valuable thing you can read about the company. It's called a 'red herring' because the final price isn't fixed yet. Buried in its hundreds of pages, written in deliberately plain legal language, is everything the marketing won't tell you: the company's real financials over several years, its debts, its dependence on a few big customers, the lawsuits against it, how the promoters have used company money, and a frank risk factors section the company is legally obliged to write against its own interest.

Almost nobody reads it, which is precisely why reading even parts of it gives you an edge over the crowd chasing the same hyped issue. You don't need to digest all 400 pages. The financial summary, the objects of the issue, the risk factors, and the promoter-and-shareholding sections will tell you most of what you need to decide whether the festival is worth attending.

Fixed price vs book building: how the price is set

There are two ways to price an IPO, and almost every meaningful Indian IPO uses the second.

• Fixed price — the company simply announces one price, and you apply at that price. Simple, but rare for large issues.
• Book building — the company announces a price band (a floor and a cap, say ₹95 to ₹100, hypothetically), and investors bid within it. Demand across all the bids 'builds the book', and the final cut-off price is set based on where the demand actually lands.

Book building is a demand-discovery mechanism. The band is the company and its bankers saying 'we think it's worth somewhere in here'; the bids are the market answering. As a retail investor you'll usually just bid at the cut-off, meaning 'I accept whatever final price the book settles on within the band'. That's the simplest and most common choice.

How the pie is divided

An Indian IPO doesn't just sell to whoever shows up first. SEBI requires the offer to be carved into reserved buckets, so that big institutions can't crowd out small investors entirely. The three broad categories are:

• QIBs (Qualified Institutional Buyers) — mutual funds, insurers, foreign institutional investors. The professionals.
• NIIs / HNIs (Non-Institutional Investors) — wealthy individuals and corporates applying above the retail limit.
• Retail individual investors — ordinary people like you, applying up to a capped amount per application.

A fixed slice of the offer is reserved for retail, which is the system deliberately protecting small investors' access. It also explains a quirk you'll meet in the next chapter: when a hot IPO is oversubscribed in the retail category — far more applications than shares reserved for it — shares are handed out by lottery rather than first-come-first-served. Your application time has no effect; everyone in the retail bucket has the same odds.

So is an IPO a good investment?

It depends entirely on the price relative to the business — exactly as with any share you'd buy on the open market. The IPO wrapper changes nothing about that fundamental truth; it just adds noise, scarcity and excitement on top. A wonderful company at a punishing IPO price is a poor investment. A solid company at a fair IPO price can be a fine one. The festival atmosphere is engineered to make you feel you'll miss out if you don't apply, and that fear is the seller's most useful tool. Treat an IPO as you'd treat any purchase: read the DRHP, form a view on the business, decide what it's worth, and let the hype wash over you.