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Initial Public Offering - What Is IPO?

Initial Public Offering (IPO) changes a privately-held organization into a public organization. Thus it sets out freedom for brilliant investors to procure a good amount of profit from their investments.

Generally, investing in IPOs can be a great option in the event that you are an educated investor. However, only one out of every odd forthcoming IPO is an incredible open door. Benefits and risks go hand-in-hand. Therefore, before you join the bandwagon, it is imperative to understand the essentials.

What is Initial Public Offering?

Initial Public Offering (IPO) is the very first time an organization issues shares to the public. IPO is a public offering by a privately-held company, which sells its shares to Institutional and Retail Investors.

Thus by going public company raises capital and offers opportunities for secondary offerings of shares in the future. Therefore, an Initial Public Offering is also an opportunity for venture capitalists and other investors to cash out and take profits.

Before IPO, an organization has very limited shareholders including founders, angel investors, and venture capitalists. With Initial Public Offering, the company opens its shares for sale to the public.

Allocation of Shares in an IPO

There are three types of investor categories when it comes to IPO’s as follows,

First - Retail Individual Investor
Second - Non-Institutional Investor
Third - Qualified Institutional Investor

Generally, the allocation of shares varies across all the above groups in an IPO.

Individual investors come under the first category. ie. Retail Investors. Individual investors can invest in small lots worth Rs. 10000-15000. One can apply for a max. of INR 2 Lakhs in an IPO.

The number of applications received determines the total demand for shares.

Accordingly, it offers a full allotment of shares when demand is less than or equal to the number of shares in the retail category.

And when the demand is higher than the allocations, we call it Oversubscription.

For five times, you can over-subscribe an IPO. It means that the demand for shares exceeds the supply by 5 times.

As a result, the shares offered to Retail Investors are on the basis of a lottery. The computerized process makes sure fair allocation of shares to the investors.

 

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Why does a company go Public?

1. To raise capital.

Every organization requires money to scale up its operations, create new offerings and pay off existing debts. For that reason, going public is the best way to gain this much-needed capital for an organization.

2. Allowing early investors as well as owners to sell their stake to make money.

IPO is an exit strategy for initial investors and venture capitalists. An organization becomes liquid with the sale of stocks in an IPO. Venture capitalists sell their stock in the company to reap benefits and exits from the company.

3. Greater public awareness.

IPOs are ‘star marked' in the calendar of the stock market. There are a buzz and a lot of publicity around these events. Therefore, it is the best way for an organization to publicize its services and products to a new set of customers in the market.

How an Initial Public Offering is issued?

During an initial public offering (IPO), an organization  issues its shares to public shareholders(retail investors) for the very first time

What is the procedure of IPO?

A private company needs to take various steps to go public. They are as follows:

1. Selection of an investment bank

The first step is the selection of an investment bank as an underwriter. Here, the role of an investment bank is to aid and assist the organization to establish various details such as

  • Firstly, how much money the organization wants to raise?
  • Secondly, the category of securities that are offered.
  • Thirdly, the initial price per share determination.

For a large IPO, there might be more than one investment bank involved. To summarize, investment banks play a key role to facilitate in the IPO process.

2. Creating the Red Herring prospectus

The second step of the IPO process is the creation of ‘Red Herring Prospectus’. This is ensured with the aid of underwriters and it includes various segments like financial records, future plans for the organization, potential risks of the market, and expected share price range.

A lot of times, underwriters go on roadshows in order to engage potential institutional investors once they create the red herring prospectus.

3. SEBI approval

The next step is to get approval. For this, it introduces the prospectus to the Securities and Exchange Board of India (SEBI). If satisfies SEBI, they give green-lights to the initial public offering (IPO) process.

In addition, it also provides a date and time for the IPO. But if it does not satisfy SEBI, they generally ask for changes in the prospectus that can be shared with public investors.

4. Stock exchange approval

Listing is a complete process where securities are given permission to deal on a recognized stock exchange. But for that to happen, the organization must be approved by the exchange.

For example, the Bombay Stock Exchange (BSE) has a listing department, dedicated to granting approval for securities of companies. An organization has to follow the BSE's list of criteria to list on its exchange.

Let's take an example:

  • Firstly, the minimum issue size should be Rs Ten crore.
  • Secondly, the minimum market capitalization of the company should be Rs Twenty-Five crore.
  • Thirdly, the minimum post-issue paid-up capital of the company should be Rs Ten crore.

Only if the organization follows these criteria, it is eligible to get approval from the BSE.

5. Subscription of shares

Once you complete all the formalities, the company makes the shares available to all investors. This is done on the dates mentioned in the prospectus. Investors who want to apply for shares need to fill out and submit the IPO application form.

6. Listing

The shares are allotted to all categories of investors based on the demand and price quoted in their IPO application forms. Once this is completed, investors get the shares credited to their DEMAT account.

If there is oversubscription (if the demand for shares is greater than the number of shares floated by the company), investors may not obtain the number of shares they originally wanted.

After a lottery, they may get a lesser number of shares. Some investors may not even get single shares. In these cases, these investors get a complete refund of their money.

Initial Public Offering - What is IPO?

How can you benefit from an Initial Public Offering?

1. Leveraging First-mover advantage

This applies to the case where reputed companies announce an IPO. Investors get a chance to buy the company’s shares at a very lower price. The reason behind this is that once the company’s shares reach the secondary market, the share price may rise sharply.

2. High returns on investment

If the organization has the potential to grow, buying shares in an IPO can be very profitable to you. Strong fundamentals of the organization mean that it has a fair chance of growing bigger. This can be profitable to you as well. You get a chance to earn exciting returns over the long-term.

3. Listing gains

When an organization gets listed on the stock market, it may be traded at a price that is either greater or lower than the allotment price. Listing gains is when the opening price is greater than the allotment price.

Generally, investors want an IPO to perform well on listing because of factors like market demand and positive bias. But, this does not every time happen every. It is possible for a stock price to fall by the end of the first trading day.

In reality, listing gains may not result in profitable returns for the investor in the long term. It is suitable if you are a trader who wants quick returns. However, for long-term investors, it is crucial to recognize a company that can offer high returns 5 or even 10 years down the line.

Investing in an Initial Public Offering

Investors betting on an IPO can earn good returns if they are wise with some expertise. The investors can decide by going through the prospectus of the organization initiating IPO.

They have to go through the IPO prospectus carefully to form an informed idea about the organization’s business plans and its reason for raising stocks in the market. But, you must be watchful and have a sound understanding of analyzing financial metrics in order to identify the opportunities.

An unlisted organization announces an initial public offering (IPO) when it decides to raise funds through the sale of securities or shares for the 1st  time to the public.

IPO is the process of selling securities to the public in the primary market.  After listing on the stock exchange, the organization becomes a publicly-traded company and the shares of the company can be traded freely in the open market.

Types of Initial Public Offering

An issuer is an organization that issues shares to the public. There are two types of IPO.

1. Fixed Price Offering

Fixed Price IPO is the issue price that few companies set for the initial sale of their shares.

2. Book Building Offering

In book building, the organization initiating an IPO offers a 20% price band on the stocks to the investors. All interested investors bid on the shares before fixing the final price.

IPO is generally used by small and medium enterprises, start-ups, and other new organizations for expansion, improve their current business. An IPO is an option for organizations to acquire fresh capital, which in turn can be utilized to finance research, fund capital expenditure, reducing debt, and explore other opportunities.

An IPO brings transparency into the transactions of the company as it requires presenting financial data and other market-related developments to the stock exchanges.

The organization's investment in various equity and bond instruments would fall under high scrutiny after it gets listed. IPO of any organization brings a great deal of buzz and credibility. Analysts across the world report on the investment decisions of the clients.

Conclusion

IPOs are very big events in the stock market because of many reasons. By investing in the right company, you can earn a great number of returns in the long run. But the key is to determine the good performers from the rest.

FAQ's About IPOs

Bid should remain open in book building for minimum how many days?

Minimum of 3 working days.

Is the net offer to public and issue price for placement portion same?

Yes.

In case of book building, what is the floor price?

The floor price is the minimum price at which bids can be made.

Can the Individual Investor use book building facility for making an application?

Yes.

Can we hold more than one issue simultaneously using NSE IPO system?

Yes.

Can the bidder revise his bids?

Yes.

Is it possible to enter bids less than floor price?

No. It gets automatically rejected by the system if the bids if the price is less than the floor price.

 

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