If you’re actively following news and events, chances are you must have heard about the term IPO in the Share market due to the large number of IPOs getting listed.
IPO stands for Initial Public Offering. It is a process of converting a privately held company into a public company. IPO investments also generate opportunities for the investors to get high returns on their investments.
What is an IPO?
Any unlisted company or privately held company announces its initial public offering when it decides to raise funds through the sale of its shares or securities for the first time to the public. IPO investment is buying a private company’s shares or securities when made available in the primary market. The primary market deals with new securities when issued for the first time. After they are listed on the stock exchange, the company becomes a publicly traded company, and its shares can be freely traded in the open market.
How Does a Company Offer an IPO?
Step 1: Hiring an underwriter
The company will onboard a financial expert such as an investment banker. The underwriters act as an intermediary between the company and the investors. The investment bankers or the experts will also study the required financial parameters of the company and sign an agreement.
The underwriting agreement contains the following:
- Details of the Deal
- Amount to be raised
- Details of securities (being issued)
Step 2: Registration for an IPO
Registration involves preparing a registration statement and a red herring prospectus (RHP) which is a draft prospectus. Submission of the RHP is mandatory according to the companies act. The RHP contains all of the mandatory disclosures as per SEBI and the companies act. The key components are as follows.
Definitions of industry-specific terms:
- Key Risk Factors: Disclosure of all of the possible risks that can impact the company’s finances
- Use of the capital raised: Disclosure of how the capital raised will be put to use.
- Industry Description: Forecasts and predictions of the industry sector the company will be working in
- Business Description: This part talks about the core business activities of the company
- Management: Description of the key management personnel
- Financial Description: This section talks about the financial Statements along with the audit report
- Legal information: Disclosure of any litigation against the company and other miscellaneous information.
Step 3: SEBI verification
In this step, SEBI verifies the facts disclosed by SEBI; only when SEBI approves the application can the company announce its IPO launch date.
Step 4: Application to the Stock Exchange
For floating its initial issue, the company will have to apply to the respective Stock exchange.
Step 5: Creating the Buzz
Before an IPO opens to the public and to make it a success, the company has to create a buzz in the market through various marketing strategies, which include but are not limited to AMAs, Q&As, virtual road shows, etc.
Step 6: IPO Pricing
The company can now price its IPO, through a Fixed Price IPO or Bookbinding offering. In the case of a Fixed Price offering, the price of the stock is announced in advance. In the bookbinding, a price range of 20% is announced, after which the investors place their bids within the price range. The company also provides IPO Floor Price (The minimum bid price) and the IPO Cap Price (The highest bidding price). The booking is open for about three to five days generally.
Step7: Allotment of Shares
Once the price is finalized, the company, with the help of underwriters, determines the number of shares to be allotted to each investor. If there is an oversubscription, partial allotment will take place.
Types of IPO
The company issuing shares or launches its IPO in the share market is known as the issuer.
There are two common types of IPO Offerings:
1> Fixed Price Offering:
Fixed price IPO is when companies set an issue price for the initial sale of their shares.
2> Book Building Offering:
In this, the company launching its IPO in the share market offers its investors a 20% price band on the stocks. Then the interested investors bid on the final price.
IPOs allow small and medium enterprises, startups, or new companies to expand and improve their existing ventures. Initial Public Offering is one of the promising ways for a company to raise fresh capital, which can then be used for Research and development, reduce debt, and explore new opportunities. An IPO also brings transparency to the operational & Financial affairs of the company; since the company is obligated to inform the finances and other developments to the stock exchanges, the IPO of any company attracts a great deal of attention and credibility.
How to invest in an IPO
Investing in an IPO is easy, but it still requires a few steps to be understood to master the IPO investment game. Following the right path, one can easily take advantage of the upcoming IPOs in the market and possibly add the relevant latest IPO offering to the portfolio. The steps a smart investor needs to follow are –
The primary step would be identifying and deciding which IPO the investor wants to apply for. This can be a daunting experience for new investors. Investors can easily make an informed decision by going through the prospectus of the companies initiating the IPO.
The prospectus will help the investor better understand the business plan and the reason behind raising capital through an initial public offering.
Once the investor has identified and selected the IPO they are interested in investing in, the investor will have to look forward to arranging the funds for the same, the investor can easily invest using their savings, and if the savings are not enough, the investor can take up a loan from banks or NBFCs.
3> Open a Demat-Cum Trading Account:
An investor can easily apply for an IPO through their Bank account or trading account. Some of the institutions will offer a 3-in-1 account of Banking, Demat, and trading accounts in one.
After creating the Demat cum trading account, the investor needs to understand the Application Supported by Blocked Account(ASBA) facility. ASBA is an application that allows banks to block funds in the applicant’s bank account. It is mandatory for every IPO applicant.
The ASBA application forms can be obtained by the applicant in both Physical and Demat forms. Cheques and Demand Drafts can not be used to avail of this facility. The investor would need to specify the Demat account number, PAN, bidding details, and the Bank Account number in the application.
The investor would need to bid while applying for the shares in an initial public offering. It is based on the lot size quoted in the company’s prospectus. The lot size is the minimum number of shares the investor can apply for in an IPO. The investor is required to bid within the stipulated price range. Though the bidding can be revised, the funds will have to be blocked; this arrested or blocked amount will keep earning interest until the allotment process has started.
The demand for shares often exceeds the number of stocks being released in the secondary market. There could be scenarios where an investor can get fewer shares than the one he applied for. In this case, the bank unblocks the remaining partial funds.
But if the investor gets a full allotment, he gets a confirmatory allotment number (CAN), and in six working days, the IPO process is completed, and the allotted shares are then credited to the investor’s Demat account.
Initial Public offerings come with a lot of benefits as it allows the issuer company to enlarge its equity base and also help in increasing the reputation, exposure, and credibility of the company. It allows investors to generate high returns while exploring new opportunities. However, one needs to have a close understanding of the financial metrics to identify relevant opportunities