Don’t Jump Into an IPO Without Checking These Facts

Initial Public Offerings (IPOs) offer investors the opportunity to invest in a company before its shares become available on the open market. The excitement and potential for high returns often attract retail and institutional investors alike. However, before rushing into an IPO, it is essential to evaluate the company’s fundamentals, risk factors, and financing options such as IPO financing and ESOP financing.

Here are the most important facts to check before applying for an IPO in 2025.

Understand the business and its revenue model

Before investing, make sure you understand what the company does, how it earns money, and what sector it operates in. Read the Draft Red Herring Prospectus (DRHP) carefully, which is submitted to SEBI before an IPO launch.

Key aspects to check include:

• Business model and scalability
• Revenue sources and profitability trend
• Key clients or partners
• Growth strategy and future plans

If the company is in a highly competitive or emerging sector, it is crucial to assess whether its model is sustainable and how it compares to listed peers.

For employees, ESOP financing can be a useful option to participate in IPOs by funding the purchase of shares allotted under employee stock option plans. It enables ownership without immediate financial burden.

Review the company’s financial performance

The financials in the DRHP give insight into the company’s operational strength. Look into at least three years of data (where available) to check:

• Total revenue and year-on-year growth
• Net profits or losses
• Debt levels and interest coverage
• Free cash flow generation
• Return on equity (RoE) and return on capital employed (RoCE)

Be wary of companies with inconsistent earnings, high leverage, or negative cash flows, especially if they are commanding a premium valuation.

Evaluate the purpose of the IPO

One of the most overlooked facts is the use of proceeds from the IPO. Companies may raise capital to:

• Repay debt
• Fund expansion or acquisitions
• Meet working capital needs
• Provide an exit for existing investors

If a large portion of the offer is an Offer for Sale (OFS), it means the promoters or early investors are selling their stake. While not always a red flag, it is advisable to investigate further why key stakeholders are exiting at the listing stage.

Analyse valuations and pricing

IPO pricing is usually decided through a book-building process and reflects the company’s perceived future potential. However, not all IPOs are priced reasonably. To assess valuation:

• Compare the Price-to-Earnings (P/E) and Price-to-Book (P/B) ratios with similar listed companies.
• Check if the IPO is priced at a discount or premium to peers.
• Analyse growth metrics such as Earnings Per Share (EPS) and forward-looking guidance, if available.

Overvalued IPOs may underperform post-listing, so investors should always make a comparative valuation study.

Understand the risks and red flags

Every IPO comes with specific risks, which are outlined in the risk factors section of the DRHP. Pay close attention to:

• Pending litigations or regulatory issues
• High dependence on a few clients or regions
• Unfavourable industry trends
• Corporate governance concerns
  

If the company is too new, lacks a proven track record, or shows signs of aggressive accounting practices, it may be wise to wait and watch.

Consider IPO financing options cautiously

IPO financing is a popular tool among High Net Worth Individuals (HNIs) who want to apply for large IPO allocations without blocking their own capital. It involves borrowing funds from NBFCs or banks to invest in an IPO, with the shares serving as implicit collateral.

While IPO financing offers the advantage of higher bidding power, it also comes with risks:

• High interest rates: The borrowing cost may range between 7% and 12% for short periods, depending on the lender and demand.
• Allocation uncertainty: There is no guarantee of getting the desired number of shares, especially in oversubscribed IPOs.
• Loss risk: If the IPO lists at a discount, the borrower may face losses and still need to repay the loan.

In 2025, with market volatility expected to remain high, use IPO financing only if you have a clear exit plan and risk appetite.

Do not ignore ESOP financing if you are an employee

Employees of start-ups or pre-IPO companies often receive Employee Stock Ownership Plans (ESOPs). When the company goes public, these employees can exercise their ESOPs and convert them into listed shares.

However, exercising ESOPs typically involves a purchase cost and tax liabilities. This is where ESOP financing becomes useful. Lenders provide a short-term loan to help employees exercise their stock options and cover related taxes. Once the shares are listed, the employee can sell them and repay the loan.

Benefits of ESOP financing include:

• No need to dip into savings to exercise ESOPs
• Flexibility to hold or sell shares after listing
• Access to pre-IPO wealth creation

Before using ESOP financing, it is important to understand the lock-in periods, tax impact, and expected listing gains. You should also evaluate whether to hold the shares post-listing or liquidate them immediately.

Check the grey market premium but do not rely on it blindly

In India, the grey market premium (GMP) is often viewed as an indicator of listing performance. While GMP can give you a sense of demand, it is not an official metric and is prone to manipulation.

Make sure you use GMP as only one of many data points. Strong fundamentals, industry tailwinds, and sensible pricing are far more reliable indicators of long-term performance than short-term speculation.

Know your investor category and allocation rules

IPO allotment depends heavily on investor category. In India, IPOs are typically divided into:

• Retail Individual Investors (RIIs) – Application value under ₹2 lakh
• High Net Worth Individuals (HNIs) – Application value above ₹2 lakh
• Qualified Institutional Buyers (QIBs) – Includes mutual funds, banks, insurance firms
• Non-Institutional Investors (NIIs) – Includes corporates and HNIs not qualifying under QIB

Each category has its own quota and allotment process. Retail investors usually face fewer oversubscription issues, while HNIs depend on pro-rata allotment, making financing decisions riskier.

Follow a disciplined IPO investment strategy

Finally, whether you are a first-time investor or a seasoned trader, it is important to follow a disciplined approach. Consider the following steps:

1. Set a clear objective: Are you investing for listing gains, long-term wealth, or sector exposure?
2. Limit exposure per IPO: Do not overcommit capital to a single offer.
3. Track lock-in periods: Especially for anchor investors, ESOP holders, and promoters.
4. Have an exit plan: Decide whether to hold, partially exit, or sell at listing.

Treat each IPO as a unique investment opportunity rather than chasing every new listing. Patience and due diligence often yield better results than hype-driven decisions.

Conclusion

Investing in an IPO can be rewarding, but it is essential to separate enthusiasm from evidence. Reviewing the company’s fundamentals, understanding IPO financing and ESOP financing, and recognising the risks involved can help you make informed decisions. With multiple financing options available and a dynamic IPO pipeline in 2025, prudent evaluation is your strongest ally.

By staying alert to red flags and analysing each offer with a critical eye, you can avoid common pitfalls and participate in IPOs with confidence and clarity.