Before an IPO, a company is privately held. Ownership sits with founders, employees and early investors. To grow further, the company may need money that is expensive to borrow, so it offers shares to the public.
The company files a detailed document with the market regulator describing its business, financial statements, risks and how it will use the money. Once approved, an issue period of about three days opens, during which anyone with a demat account can apply.
Shares are then allotted, and a few days later the shares begin trading on the exchange. From that day the price is set by buyers and sellers, not by the company.
An easy example
A bakery chain owned by two founders wants money to open 40 new outlets. Instead of borrowing everything from a bank, it sells a slice of ownership to the public and its shares start trading on the exchange.
Important note
An IPO is a way for a company to raise money or for existing owners to sell part of their stake. It is not a promise of profit for the investor.
Common mistake
Assuming a well-known brand automatically makes a good IPO. Brand familiarity and business performance are different things.