What is an Initial Public Offering (IPO) and How to Invest in Them
Unlisted companies sell securities to the public in the primary market through an IPO (Initial Public Offering). This primary capital market is where issuers raise fresh capital via IPOs or rights issues. An active secondary market promotes the primary market as investors are assured of liquidating their investments.
IPOs are the largest source of funds for both privately owned and government companies. An IPO increases a business’s credibility and publicity while helping it finance its growth and expansion.
What are IPOs, and How do They Work?
An IPO is a process through which companies (both private and government) raise funds from the public by offering their shares. When a company makes the decision to go public, it launches an IPO to offer its shares to the public. Afterwards, its shares are listed on stock exchanges, and it becomes a publicly-traded company.
The issuer, a company issuing an IPO, selects one or more investment bankers as underwriters. Their role is to help a company establish various details of the IPO (IPO size, share price, type of securities). With their help, the company files an offer document called draft red herring prospectus (DRHP) to the market regulator SEBI.
The offer document consists of all relevant information about a company, its financials, promoters, objective of the IPO, terms of the issue, etc. If SEBI approves it, a company can go ahead with its IPO.
Investors who want to apply for the IPO shares must subscribe within specified dates. Shares are allotted to applicants based on demand and quoted price. In the case of oversubscription, investors may get fewer shares while others may not get any. Once the IPO closes, these shares can be freely traded on the stock markets.
Types of IPOs in India
1. Fixed Price Issue
In this case, a company selects stock price after consultation with the underwriters. Buyers/investors come to know the price when the company announces to go public. They must pay the full share price when making the application. People can know the demand for the public issue after the IPO closes.
As per SEBI regulations, issuer companies can conduct fixed price offers after the book building offering is closed. It needs to be conducted like a normal public issue after the book building part determines the issue price.
2. Book Building Issue
Book building is a process used in IPOs for efficient price discovery, where the issuer company decides a 20% price band on the stocks. The lowest limit is the floor price, while the maximum limit is the cap price. Investors must bid within these limits.
As per SEBI guidelines, companies must issue at least 75% of an IPO through the book-building process. At least 25% of the net offer must be at a price determined through book-building.
Why Would You Want to Invest in an IPO?
Here are some reasons why you may want to invest in an IPO:
- Listing gains: When a company opens at a price higher than the allotment price upon listing, investors can get listing gains.
- Buy cheap and sell high: Often, the IPO price is at a discounted rate, which allows an investor to buy in cheap and sell high.
- Getting in early: When reputed companies announce an IPO, investors get an early bird advantage. They can buy shares at a price not available after listing on the secondary market.
- Price transparency: The IPO document shows detailed information regarding the valuation and price of shares. After listing, individual investors cannot access this type of information.
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How to Invest in the IPO of a Particular Company?
Here are the steps investors need to take to invest in the IPO of a company:
- Step 1: Do a thorough analysis of the company along with its financials and arrange funds to invest.
- Step 2: Open a Demat account; you will need to furnish your PAN, identity proof and address proof to open a new account.
- Step 3: You can apply for the IPO online through the mobile app or website of a bank or stock broking company.
- Step 4: In the Investment section of the website/app, click on the ‘IPO’ option.
- Step 5: Fill in the essential details of KYC, depository and bank accounts to complete the verification process.
- Step 6: Fill in the ASBA (Application Supported by Blocked Amount) form. You need to enter the number of shares and bid price as per your investment amount.
- Step 7: Check the terms and conditions and click to apply for the IPO.
Following a successful application, you will get an acknowledgement slip with a reference number.
Things to Check Before Investing in an IPO
- You need to check the company’s financial history and performance for the past few years to assess its growth potential.
- Read the draft red herring prospectus for overall information on an IPO. This includes the fund’s objectives, possible risks, financial statements, etc.
- A company’s valuation is another important factor to check before investing. To do this, you can compare its price to earnings ratio and return on equity.
- It is important to understand a company’s business to know its growth opportunities and resulting returns for shareholders.
- You should figure out all risks involved with the IPO from its DRHP. It is essential to check major concerns such as a company’s pending litigation and amount of liabilities.
Final Word
With several public issues upcoming, many people want to know how to invest in the IPO of popular companies. Investors betting on an IPO can get handsome returns if they have some expertise and a clear understanding of the market situation. However, you need to invest in the right company to stand a chance of earning decent returns.
FAQs
Ans: As per SEBI’s guidelines, companies must have net tangible assets of Rs. 3 crore and a net worth of Rs. 1 crore in 3 preceding years to launch an IPO. They also must have at least Rs. 15 crore in average profits (pre-tax) in 3 out of 5 years preceding the IPO.
Ans: There are three main categories of investors for IPOs. These are as follows:
Qualified Institutional Buyers: These include scheduled commercial banks, big investment firms, mutual fund houses and other large institutions.
Non-Institutional Investors: This category includes corporate bodies and high net worth individuals (HNIs).
Retail individual investors: These are individual investors who cannot apply for shares worth more than Rs. 2,00,000.
Ans: An IPO calendar has these important dates:
• Open and close dates for bidding
• Allotment date when a company announces share allotment
• Refund date for people who did not get allotment
• Credit to Demat account date
• Listing date
Ans: Over-subscription is when an IPO receives more applications than it offers to the public. Investors can over-subscribe to IPOs multiple times. If the demand is more than the supply, share allocation is done on the basis of a lottery to ensure impartial allocation.
Ans: An adult capable of entering into a legal contract can invest in IPOs. They need to have a PAN card and a valid Demat account to apply for an IPO. Although a trading account is not mandatory, you will need it to sell these stocks upon listing.
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This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.
