INTRODUCTION TO IPO?

What is an IPO?

 

An initial public offering (IPO) is the first time a company issues shares to the public. This is when a private company decides to go ‘public’.

 

In other words, a company that was privately-owned until then becomes a publicly-traded company.

 

Before the IPO, a company has very few shareholders. This includes the founders, angel investors and venture capitalists. But during an IPO, the company opens its shares for sale to the public. As an investor, you can buy shares directly from the company and become a shareholder.

 

How are shares allocated in an IPO?

 

There are different investor categories when it comes to IPOs. This includes:

 

Qualified Insititutional Buyers (QIBs)

 

Non Institutional Investors (NIIs)

 

Retail Individual Investors (RIIs)

 

The allocation of shares differs for all the above groups in an IPO. As an individual investor, you come under the last category.

 As an individual investor, you are allowed to invest in small lots worth Rs 10,000-15,000. You can apply for a maximum of Rs 2 lakh in an IPO. The total demand for shares in the retail category is judged by the number of applications received. If the demand is less than or equal to the number of shares in the retail category, you are offered a full allotment of shares.

 

When the demand is greater than the allocation, it is known as oversubscription. Many times an IPO can be over-subscribed five times over. This means that the demand for shares exceeds the supply by five times!

 

In such cases, the shares in retail category are offered to investors on the basis of a lottery. This is a computerised process that ensures impartial allocation of shares to investors.

 

Why does a Company go Public?

 

To raise capital for growth and expansion

 

Every company needs money to increase its operations, create new products or pay off existing debts. Going public is a great way to gain this much-needed capital for a company.

 

Allowing owners and early investors to sell their stake to make money

 

It is also seen as an exit strategy for initial investors and venture capitalists. A company becomes liquid through the sale of stocks in an IPO. Venture capitalists sell their stock in the company at this time to reap returns and exit from the company.

 

Greater public awareness

 

IPOs are ‘star-marked’ in the stock market calendar. There is a lot of buzz and publicity around these events. This is a great way for a company to publicise its products and services to a new set of customers in the market.

 

How is an IPO issued?

 

During an initial public offering (IPO), a company issues its shares to public shareholders for the first time. In the previous article, we understood why a private company decides to launch an IPO and how investors can benefit by investing in them.

 

The next questions that come to mind are: “How is an IPO issued?”

 

What is the IPO procedure?

 

A private company has to take various steps in order to go public. They are:

 

Selecting an investment bank

 

The first step is to select an investment bank as an underwriter. Here, the role of an investment bank is to help the company establish various details such as

 

How much money the company hopes to raise

 

The type of securities that will be offered

 

The initial price per share

 

For a large IPO, there can be multiple investment banks involved. In short, investment banks act as facilitators in the IPO process.

Creating the Red Herring prospectus

 

The next step of the IPO process is to create the ‘Red Herring Prospectus’. This is done with the help of underwriters. The prospectus includes various segments such as financial records, future plans for the company, potential risks in the market and expected share price range. Many times, underwriters go on road shows in order to attract potential institutional investors after they create the red herring prospectus.

 

SEBI approval

 

The prospectus is presented to the Securities and Exchange Board of India (SEBI). If SEBI is satisfied, it green-lights the initial public offering (IPO) process. In addition, it also gives a date and time for the IPO. But in case SEBI is not satisfied, it asks for changes to be made before the prospectus can be shared with public investors.

 

Stock exchange approval

 

Listing is the process where securities are allowed to deal on a recognised stock exchange. But for that to happen, the company needs to be approved by the exchange. For instance, the Bombay Stock Exchange (BSE) has a listing department whose purpose is to grant approval for securities of companies. The BSE has a list of criteria which needs to be followed for the company to be listed on its exchange.

 

For example:

 

The minimum issue size should be Rs 10 crore.

 

The minimum market capitalization of the company should be Rs 25 crore.

 

The minimum post issue paid-up capital of the company should be Rs 10 crore.

 

Only if the company follows these criteria, it gets an approval from the BSE.

 

Subscription of shares

 

Once all the formalities are done, the company makes the shares available to investors. This is done on the dates specified in the prospectus. Investors who wish to apply for shares have to fill out and submit the IPO application form.

 

Listing

 

The shares are allotted to different investors based on the demand and price quoted in their IPO application forms. Once this is done, investors get the shares credited to their demat account. In case of oversubscription (if the demand for shares is higher than the number of shares floated by the company), investors may not get the number of shares they originally wanted. They may get fewer shares after a lottery is done. Some investors may not even get any shares. In such cases, these investors get a refund of their money.

 How can you benefit from an IPO?

 

First-mover advantage

 

This is especially true when reputed companies announce an IPO. You get a chance to buy the company’s shares at a much lower price. This is because once the company’s shares reach the secondary market, the share price may go up sharply.

 

High returns

 

If the company has a potential to grow, buying shares in an IPO can be benefit you. Strong fundamentals of the company mean that it has a good chance of growing bigger. This can be advantageous to you as well. You stand a chance to earn good returns over the long-term.

 

Listing gains

 

When a company gets listed on the stock market, it may be traded at a price that is either higher or lower than the allotment price. When the opening price is higher than the allotment price, it is known as listing gains.

 

Generally, investors expect an IPO to perform well on listing due to factors such as market demand and positive bias. However, this does not always happen. It is possible for a stock price to drop by the end of the first trading day too.

 

In reality, listing gains may not actually result in good returns for the investor in the long term. So, if you are a trader interested in quick returns, it may be suitable. But for long term investors, it is important to identify a company that can offer high returns five or even ten years down the line.

 

To sum up

 

IPOs are big events in the stock market for a reason. By investing in the right company, you stand a chance to earn good returns in the long run. But the trick is to identify the good performers from the rest.