What is an IPO, and why does a company go public?
The answer
An initial public offering is the first time a company's shares are sold to the general public and listed on an exchange. After it, anybody can buy them and the company must publish its results on a fixed schedule.
Going public is not one decision. It is a trade: the company accepts permanent disclosure and outside owners, in exchange for money, a market price, and a way for its existing owners to leave.
Why this costs you money
You already know the core of this from the earlier lesson on primary and secondary markets: in an IPO the seller chooses the price and the date, and you should check how much of the issue is a fresh issue and how much is an exit. Assume that is done.
This article is about the question that comes next, and it is the one almost nobody asks. Why is this company going public at all?
Here is the loss. An investor reads the growth story, checks the price band against a peer's valuation, decides it looks reasonable and applies. What they never establish is which of 6 possible reasons is driving the listing. Those 6 reasons produce very different outcomes, and 3 of them are warnings.
A company listing because it needs ₹2,000 crore to build 3 factories is in a different situation from a company listing because a fund that invested 9 years ago has run out of time, or because a lender has asked the promoter to reduce debt, or because the sector is expensive this quarter and the bankers said now.
The second loss is bigger and slower. A newly listed company has almost no public record. A company listed for 20 years has around 80 quarters of audited results, several management changes and at least 1 downturn on file. A company listed 8 months ago has 2 quarters. You are paying a price built from a story, and the evidence to check the story does not exist yet.
How it works
A company is private. Its shares are owned by founders, employees, family and professional investors, and they are hard to sell because there is no market. To go public, the company does 4 things.
- Prepares a disclosure document. Every material fact about the business, its finances, its litigation and its risks, in one document, signed off by directors and auditors.
- Files it with the regulator, which reviews it for completeness. In India this is SEBI. In the United States it is the SEC.
- Sells shares — new ones, existing ones, or both — through banks.
- Lists on an exchange, after which the shares trade freely and the reporting obligations begin.
Now the reasons. There are 6, and a real IPO usually has 2 or 3 of them.
1. Capital for the business. The company needs money it cannot borrow cheaply, for capacity, research, or regulatory capital. This is the textbook reason and it is genuinely common in manufacturing, banking and infrastructure.
2. An exit for early investors. Venture and private equity funds have a fixed life, often around 10 years. They must return money to their own investors. An IPO is the largest available exit.
3. A currency. Listed shares can be used to pay for acquisitions and to pay employees. A private company must pay cash for both.
4. Repaying debt. The prospectus will say so plainly, under Objects of the Issue. Equity raised to repay borrowings reduces risk, and it also means the money is not building anything new.
5. A published valuation. A market price makes the owners' wealth real, measurable and usable as collateral.
6. Because somebody requires it. A regulator, a lender, a shareholder agreement, or a rule about how many shareholders a private company may have.
The costs the company accepts. Quarterly results and continuous disclosure. Legal and compliance expense that does not stop. A price on a screen every day that management now watches. Reduced control, because outside shareholders vote. And a permanent obligation to explain itself.
What it tells you, and what it does not
The reason for listing is the most predictive thing in the prospectus, and it is stated in plain language. Objects of the Issue tells you where fresh money goes. The list of selling shareholders tells you who is leaving. Those 2 pages together answer the "why".
What the reason does not tell you is whether the company is good or the price is fair.
A fund exiting after 9 years is not evidence of a bad business. Funds have to exit. A company raising capacity money is not evidence of a good one; plenty of companies have raised money to build factories nobody needed.
The reason tells you what the transaction is for. It tells you nothing about what the shares are worth. Those are separate questions and mixing them is how people end up arguing about intentions instead of numbers.
There is one more limit worth naming. The prospectus is written by people who want the offer to succeed. It is legally required to be accurate and complete. It is not required to be balanced. The risk factors section is exhaustive and deliberately unranked, so the risk that will actually matter sits in a list of 60 that all look equally serious.
The decision rule
Before you form any view on an IPO's price, finish this sentence from the prospectus itself, not from a news article:
"This company is going public in order to ______, and after the money is raised the person who benefits most is ______."
If the blanks are filled with "build or expand something specific" and "the company", the listing is doing the job listings exist to do.
If they are filled with "provide an exit" and "a shareholder who has been here for 9 years", the listing may still be a fine investment, but you are now in a negotiation, not a fundraising, and the other side has been preparing for it for a year.
Try this now
Five minutes, on your own portfolio. This one surprises most people.
- Open your holdings and list every stock you own.
- For each, find the listing date. In India, the NSE and BSE stock pages show "Date of Listing" in the company information section. In the United States, the company's profile page or its first Form 10-K will show it.
- Write the number of years of public record next to each holding.
- Add up the value of everything listed less than 3 years ago and divide by your total portfolio value. That is your exposure to companies with almost no public history.
- Take your newest holding. Open its prospectus — search the company name plus "RHP" in India, or find its Form S-1 on the SEC's EDGAR system in the United States. Read only 2 things: the Objects of the Issue, and the first 5 risk factors.
What you should see. Most portfolios split into 2 groups. Older holdings have decades of results, and you probably bought them for reasons you can state. Newer holdings have 2 to 8 quarters of public results, and you probably bought them for a reason you heard.
The percentage from step 4 is the number to keep. There is no correct level for it. But if 40% of your money sits in companies that have never published a result during a downturn, you should have chosen that on purpose rather than arrived at it.
Three real cases
1. Facebook, May 2012 (United States) — going public because a rule forced it Facebook filed its Form S-1 on 1 February 2012 and listed on 18 May 2012 at $38 per share. It did not need the money in any urgent sense. A large part of the reason was structural: US rules at the time required a private company that passed a threshold of holders of record to register with the SEC and start reporting like a public company anyway. Once a company must report, the argument for staying private largely disappears. The JOBS Act of 2012 raised that threshold to 2,000 holders of record shortly afterwards, which is one reason later American companies were able to stay private far longer.
2. Life Insurance Corporation of India, May 2022 (India) — the owner's reason, not the company's LIC's offer was made entirely by its owner, the Government of India, selling a small slice of its holding. LIC the company received nothing. The government's reason was its own disinvestment target for the year. The issue was scaled down from earlier expectations of ₹60,000 crore or more to about ₹21,000 crore , and it listed below its issue price. Every part of that was disclosed in advance. The lesson is not that the IPO was bad. It is that the "why" here belonged to the seller, and the company's own needs were not part of the answer.
3. Spotify, 3 April 2018 (United States) — going public without an IPO at all Spotify listed on the New York Stock Exchange through a direct listing. It sold no new shares, raised no money, and used no underwriters to set a price. The exchange published a reference price of $132, and the first trade happened at $165.90, set purely by supply and demand on the morning. The company went public because its existing shareholders wanted to be able to sell, not because it needed capital. This case is the cleanest proof that "IPO" and "going public" are 2 different things.
The question that resolves it
A novice reads an IPO prospectus and asks: is this a good company?
An expert asks: whose problem is this listing solving?
The answer is written down, in a section with a heading, in a document that costs nothing to download. It takes 4 minutes to find, and it reframes everything else in the offer.
What would make this wrong
If going public were reliably a sign of a company at a good moment, then IPOs as a group would beat the market. The long-run research points the other way: newly listed companies as a group tend to jump on the first day and then underperform over the following 3 to 5 years. That pattern shows up across countries and decades.
The honest limits:
The average hides enormous variation. Some of the largest companies on earth were bought at their IPO by people who did very well. A category-level result is not a prediction about a single company.
The pattern also depends on when you measure. IPO cohorts from quiet markets have behaved very differently from cohorts issued during a boom, which is a statement about the market's mood at the time of issue rather than about listings in general.
And this article's central claim — that the reason for listing is predictive — is a claim about where to look, not a scoring system. A company that lists to fund real expansion can still be badly run. A fund exit can still be a fine business at a fair price.
In India
An Indian IPO is a heavily specified public process.
Eligibility. SEBI's regulations set out 2 routes. A company with a track record of profits and net worth over defined periods can list through the normal route. A company that fails those tests can still list, but must sell at least 75% of the issue to qualified institutional buyers, which puts institutions rather than retail investors in the position of judging it. That single rule is why loss-making companies in India have a different quota structure from profitable ones.
Minimum public shareholding. After listing, at least 25% of the shares must be held by the public, with a period allowed to reach it for very large issues. This is why India has so many offers for sale, as described in the previous article.
The SME platforms. The NSE and BSE run separate platforms for small and medium companies, with lighter requirements and a much larger minimum application size. By count, these dominate Indian IPO activity in many years. They allow you to buy a company with very small revenue on a public exchange, and they are where the least public record exists.
Documents. The draft prospectus is the DRHP, the updated version after SEBI's comments is the RHP, and the final one filed with the price is the prospectus. All are free on SEBI's website, the exchange sites and the lead bank's site.
In the United States
A US company has a menu, and the menu is the point.
The traditional IPO. File a Form S-1 with the SEC, respond to comments, run a roadshow, price the deal with underwriters, and list. Smaller companies can file confidentially and use reduced disclosure as an emerging growth company under the JOBS Act.
The direct listing. Existing shares are listed without underwriters setting a price and, in the original form, without raising money. Both the NYSE and Nasdaq later obtained approval to allow companies to raise capital in a direct listing as well.
The SPAC merger. A shell company raises cash in its own IPO, lists, and then merges with a private business, which becomes public through the merger. This route peaked hard: roughly 250 SPAC IPOs raised more than $83 billion in 2020, and 613 raised about $162 billion in 2021, before collapsing to 86 IPOs and $13.4 billion in 2022. Studies of SPACs that completed mergers between July 2020 and December 2021 found mean share prices around $3.85 against the standard $10 redemption value.
Staying private. American companies now stay private much longer than they once did, because private capital is abundant and the reporting threshold is high. Many of the largest recent listings arrived after 10 or 15 years of private growth.
Where they differ, and what that tells you
India and the United States now have close to opposite problems, and both of them are risks to a buyer.
In the United States, you usually arrive late. A company that stayed private for 12 years and raised billions privately has already given its steepest growth to private investors. By the time it lists, it is large, widely covered, and priced by professionals who have followed it for years. Your risk is paying a mature price for a company sold to you as a young one.
In India, you can arrive far too early. The SME platforms and the institutional-quota route mean a company with a short history, small revenue and no downturn on record can be offered to the public. Your risk is the opposite one: buying a business before anybody, including its management, knows what it does in a bad year.
What this tells you is which question to ask in which market.
For an American listing, the useful question is what is left. How much of the growth already happened while this was private, and who captured it?
For an Indian listing, especially a small one, the useful question is what is proven. How many years of audited results exist, do they include a bad year, and has this management ever operated under public scrutiny?
Same instrument, opposite failure mode. Advice written for one market and copied into the other misses the actual risk.
Carry this
- Find the reason for the listing before you form a view on the price.
- Count the quarters of public record you are buying. Fewer quarters, more faith.
- The prospectus must be complete. It is not required to be balanced.