Initial Public Offerings (IPOs) are one of the most exciting opportunities for investors. The idea of investing early in a promising company before it becomes a stock market giant sounds thrilling. However, the IPO journey isn’t always a smooth ride. Like every investment, IPOs carry their fair share of risks, and understanding them is crucial before putting your hard-earned money on the line.
In this comprehensive blog post, we’ll explore:
- What an IPO really is
- The major risks of applying for an IPO
- How to evaluate an IPO
- Common mistakes new investors make
- Pro tips to reduce IPO risk
🏦 What is an IPO?
An Initial Public Offering (IPO) is the process through which a private company offers its shares to the public for the first time. Once the IPO is completed, the company becomes listed on a stock exchange (such as NSE or BSE in India), and its shares are available for public trading.
Benefits of IPOs (Before We Dive into the Risks)
- Early access to growth-stage companies
- Potential for high short-term returns (listing gains)
- Opportunity to be part of a brand’s growth journey
- Liquidity for investors and employees of the company
But before getting carried away by the potential benefits, it’s important to examine the risks involved in IPO investing.
⚠️ Major Risks of Applying for an IPO
1. 📉 Overvaluation Risk
One of the most common IPO risks is overvaluation. Companies often price their shares at a premium to maximize the money raised. Due to hype and aggressive marketing, the valuation may not reflect the company’s actual performance or financials.
Example:
The Paytm IPO in 2021 was priced aggressively. Although it was one of the largest IPOs in India, its stock crashed nearly 27% on the listing day and continued to decline afterward.
Key Takeaway: A high IPO price doesn’t always mean value; it may mean risk.
2. 🧾 Lack of Historical Data
IPO-bound companies may not have a long track record of performance that retail investors can analyze. Their financial disclosures are often limited to 3 years, making it difficult to judge consistency or sustainability.
Red Flag: If a company has only recently become profitable, or is still incurring losses, it may not be a stable investment.
3. 📊 Market Volatility Impact
Stock markets are highly volatile, and IPOs are especially sensitive. A market downturn close to the listing date can negatively impact the IPO performance, regardless of the company’s fundamentals.
Example: Even fundamentally strong IPOs can list at a discount during global or domestic market corrections.
4. 💰 Limited Allotment or No Allotment
Retail investors often don’t receive full or any allotment due to high demand. IPO applications get oversubscribed many times over, and shares are allocated via a lottery system.
What This Means:
- You may lock funds for days and still get no shares.
- Opportunity cost of idle capital.
5. 🧪 Inexperienced Management Team
In many IPOs, especially those from new-age startups, the management team may lack experience in handling large public companies. If leadership lacks vision or governance skills, it can affect the company’s post-IPO performance.
Check: Look at the founders’ past experience and decision-making history.
6. 📉 Poor Post-Listing Performance
It’s common to see IPOs initially rise (listing gains) and then fall as the hype dies down. Sometimes, early investors like PE funds or founders may offload their shares once the lock-in period ends, creating selling pressure.
Real-Life Example: Zomato IPO initially surged but declined in the following months due to concerns over losses and cash burn.
7. 🚧 Regulatory and Compliance Risks
Post-IPO companies are subject to stricter scrutiny by regulatory bodies like SEBI. Any issues in compliance, legal cases, or regulatory penalties can severely impact share prices.
Note: Always read the Red Herring Prospectus (RHP) for any existing legal or tax issues.
8. 🧾 Business Model Uncertainty
Some companies that go public are in experimental or loss-making sectors (like fintech, SaaS, or e-commerce). Their revenue models may not be sustainable in the long term.
Ask Yourself: Does the company have a clear plan to become profitable?
9. ⏳ Lock-in Period for Promoters and Investors
Large investors (like venture capital firms) and promoters have a lock-in period during which they can’t sell shares. Once this period ends, massive sell-offs can crash the stock price.
10. 📈 Speculative Hype and Herd Mentality
Many investors apply for IPOs just because everyone else is. Social media, WhatsApp groups, and YouTube “gurus” can create FOMO (Fear of Missing Out), leading to ill-informed decisions.
Reminder: Investment decisions should be based on analysis, not emotions.
🧠 How to Evaluate IPOs Before Applying
To reduce the risks of IPO investing, follow this checklist:
✅ Read the Red Herring Prospectus (RHP)
This is a legal document with full company details—financials, risks, litigation, promoter background, etc.
✅ Analyze Key Financial Ratios
- Revenue growth
- Profitability
- Debt levels
- Cash flows
- Return on Equity (ROE)
✅ Compare with Peers
Benchmark the IPO company’s valuation against listed competitors in the same sector.
✅ Look at Use of IPO Proceeds
Is the company using funds for:
- Debt repayment? (Good)
- Expanding capacity? (Neutral)
- General corporate purpose with no specifics? (Caution)
✅ Management Team
Check their experience, education, and track record of delivering results.
🚫 Common Mistakes to Avoid When Applying for IPOs
- Applying blindly based on hype
- Not checking the company’s fundamentals
- Investing all savings into IPOs
- Ignoring valuation metrics like P/E ratio
- Focusing only on listing gains instead of long-term value
🛡️ How to Reduce the Risks of IPO Investment
Here are a few practical tips:
1. Apply Through ASBA Only
This ensures your funds remain in your bank account until allotment.
2. Limit Exposure
Don’t put more than 10-15% of your portfolio into IPOs.
3. Wait and Watch
Sometimes, it’s safer to wait until after the listing. Post-listing price corrections often give better entry points.
4. Diversify
Don’t just apply for tech IPOs. Diversify across sectors and industries.
5. Watch Grey Market Premium (GMP) Carefully
Grey Market Premiums can give clues about sentiment but shouldn’t be the sole factor for decision-making.
📌 Should You Apply for Every IPO?
Absolutely not.
Just because a company is going public doesn’t mean it’s a good investment. Apply only when:
- The business model is sustainable
- The financials are strong
- The IPO price is reasonable
- You understand the sector and its future potential
📈 Is It Better to Invest in IPOs or Buy Later?
Sometimes, it’s smarter to wait until after the IPO to buy shares. Once the hype settles, prices may correct, offering a better value entry.
Example: Many successful companies like IRCTC, Nykaa, and LIC corrected significantly after listing, offering better opportunities to enter later.
🔍 Real-Life Case Studies of IPO Risk
📉 Paytm IPO (2021)
- Issue Price: ₹2,150
- Listing Day: -27%
- Reason: Overvaluation, unclear profitability roadmap
📉 LIC IPO (2022)
- Issue Price: ₹949
- Now: Trading below issue price
- Reason: Government divestment concerns, weak retail sentiment
✅ IRFC IPO (2021)
- Issued at ₹26
- Decent stable growth, backed by government
- Risk: Public sector perception
🧾 Final Thoughts: IPOs Are Not Always Golden Tickets
IPOs can be an exciting way to invest in growth stories early, but they come with risks you can’t afford to ignore. The key to IPO success lies in education, research, and patience.
If you treat IPOs like a lottery, you may win once but lose long-term. But if you approach them like a smart investor—analyzing risk, checking facts, and managing expectations—you can build lasting wealth.
🔑 Key Takeaways
- Not every IPO is a good investment.
- Hype and speculation often overshadow real risks.
- Always read the company’s Red Herring Prospectus.
- Consider listing gains vs long-term value.
- Manage IPO exposure in your portfolio wisely.
📣 Frequently Asked Questions (FAQs)
Q1: Is investing in IPOs risky for beginners?
Yes, beginners may not have the experience to analyze financials or market trends, making them vulnerable to losses.
Q2: Can IPOs give quick profits?
Some IPOs offer listing gains, but many fall below the issue price post-listing. It’s not guaranteed.
Q3: How to know if an IPO is overvalued?
Compare the IPO’s valuation (like P/E or P/B ratios) with competitors and check analyst opinions.
Q4: Is it safe to invest in loss-making companies’ IPOs?
Loss-making companies may have growth potential, but they carry higher risk. Proceed with caution.
Are you planning to apply for an upcoming IPO? Let us know in the comments which ones you’re watching and why.
👉 Don’t forget to bookmark this guide and share it with your investor friends who might need a reminder that not all that glitters is gold when it comes to IPOs!