What is Initial Public Offering (IPO)?
Initial Public Offering (IPO) refers to the process when the private limited company offers a part of its equity to the general public for the first time to raise capital, after that a private limited company becomes a public limited company.
In simple words, when any company’s share lists in the stock market for the first time, the company has to follow a step-by-step process to make its shares listed in the stock market which is known as IPO.
Don’t think of IPO as always a profit-making opportunity, it can also give you losses as well if you invest your money in IPOs blindly, you have to do proper research before investing in IPOs, read it till the end as I have discussed here how to do effective research for any IPO below.
Note: You will make a profit only if an IPO listing price is more than its bidding price. The listing price depends upon the market’s demand and supply.
Types of Initial Public Offering (IPO):
- Fixed price offering: Fixed Issue Price refers to the particular price that companies set for each unit of their shares offered to the general public, it remains the same for everyone who wants to invest in that company’s IPO.
- Book building offering: In this type of offering companies set up a floor price (minimum price) and cut-off price (maximum price), the difference between the floor and cut-off price can be a maximum of 20%. A person willing to invest can select any price between the floor price and the cut-off price.
Eg: DCX Systems Ltd. IPO, price range: 197-207 (floor price and cut-off price)
Why do companies launch their IPOs?
Generally, companies launch their IPOs due to the following three reasons:
- Expansion of their business
- The exit of old investors
- To repay their previous debts
Companies can raise capital from the Initial Public Offerings (IPOs) in the following two forms:
1. Fresh issue: It refers to raising capital by companies from the general public for business expansion or repaying previous debts.
2. Offer for sale: when the company’s existing investors are offering their equity shares to the general public at the time of the IPO, Converting their equity shares into cash is known as OFS. capital raised through an offer for sale is just a transfer of equity from one person to another and it will not benefit the company.
Categories of investors in IPO:
According to SEBI, there are only 4 types of investors who places a bid for an IPOs:
- Retail individual investors (RIIs): Any investor whose bid amount in an IPO is less than 2 lakh rupees, then he/she will be considered a retail individual investor. 35% of shares in an IPO arev reserved for this category of investors.
- Non-institutional investors (NIIs): They are also known as High net-worth individuals, any investor who is placing a bid of more than 2 lakh rupees in an IPO comes under the category of Non-institutional investors, 15% of total shares issued in IPO is reserved for NIIs.
- Qualified institutional investors (QII): These are the expert investors who invest very big amount of capital in IPOs, it includes mutual funds, commercial banks, foreign portfolio investors, etc. 50% of total shares issued in an IPO is reserved for QIIs.
- Anchor investors: These types of investors are introduced by SEBI in the year 2009, any Qualified institutional investor who invests the capital of more than 10 crore rupees is recognized as an Anchor investor. They have the power to apply in any IPO before it gets open for the general public, but QIIs cannot withdraw their bids after the bidding is closed as other retail and non-institutional investors can do, RIIs & NIIs can withdraw their bids anytime until the allotment of shares.
Process of Initial Public Offering (IPO):
- Appointing an Investment bank: The first function any IPO-raising company has to perform is appointing an investment bank, investment banks serve as a mediator between the investors and the company, generally, companies take the help of investment banks at the time of fund-raising or mergers. They do all the preparation of IPO on behalf of the company such as estimating valuations, DRHP/RHP preparation, minimum subscription guarantee, helping in deciding share price and lot size, etc.
- Registration of an IPO: The company with the help of an investment bank prepares all the important documents including DRHP and submits them to SEBI (Securities and Exchange Board of India) for registration of an IPO.
- Verification by SEBI: After that, SEBI verifies all the details written in DRHP, if SEBI approves the IPO then the original prospectus is prepared by the company which is known as the “Red Herring Prospectus” (DRHP is the draft version of RHP). The IPO date is then decided by the company.
- Application to the stock exchange: The company then sends an application to the stock exchanges for listing their IPO, the company can go either to NSE/BSE or both.
- Advertising of an IPO: Now, advertising of an IPO is done, staff and members of the company travel across different places for advertising to attract potential investors.
- Pricing decision: Now, the company decides the price of each share and the lot size that will be offered to the general public, it is based upon the company’s valuation. There are 2 types by which IPO pricing can be done, Fixed price offering and book building offering. (we have read about both the methods above)
- Available to the public: Initial Public Offering (IPO) is made available to the general public which means interested investors can place applications to apply for IPOs, after that if you get an allotment of shares then it will be transferred to your D-mat account otherwise your money will be refunded into your bank account within 4 days if not allotted.
How to invest in IPOs (in India):
- Firstly, you must have all the documents required to open a D-mat account, documents are an Adhaar card (or any other identity proof), a PAN card, and a Bank account.
- Then, you have to select your depositary participant (also known as a broker) accordingly, name of some popular DPs are Groww, Kite by Zerodha, Angel one, Upstox, etc.
- After that, you have to complete your KYC by uploading all the required documents and filling out all the details that are required.
- If your information is correct then your D-mat account will get activated within 24 hours, and you will receive a mail from your broker.
- You will see an option for Initial Public Offering (IPO) on your broker’s interface, go and explore it and if any company’s offering is currently active then you can apply for it, in just a few clicks.
Go to IPO section – select number of lots – select price – enter payment details – application successful – wait for allotment status
Note: Don’t invest in IPOs directly, you should have to do proper research before subscribing to any Initial Public Offering (IPO), doing proper research will help you to minimize the chances of losses.
How to analyze and select the best IPOs?
You can easily analyze any IPO just by keeping in mind the following points which are mentioned below, based on your conclusion you can make a decision either to bid or skip.
- Red herring prospectus: It is a most important document that is prepared by all the companies if they are willing to raise capital through Initial Public Offering (IPO), it contains all the important information related to IPO, such as issue type, IPO type, the amount raised, per share price, lot size, company’s business, etc. Read it carefully before making any decisions.
- Fundamentals: Check out the company’s current and past financial records such as Balance sheet, Cash flow statement, and Profit and loss statement.
- Purpose of IPO: You should know what the company is going to do with the capital raised from the following IPO.
- Financial ratios analysis.
- Competitors.
- Strengths and weaknesses of the Company.
- Valuations.
- Grey market premium.
Other important terms related to IPO
Undersubscription | When the bids placed by the investors are less than the shares issued by the company in its IPO, then it’s known as Undersubscription of IPO. |
Oversubscription | When the bids placed by the investors are more than the number of shares issued by the company in its IPO, then it’s known as an oversubscription of IPO. |
Bidding | Bidding refers to the amount that an investor is willing to pay to own shares of an IPO company, from the range or price offered by the company. |
Price band | Price band refers to the range of prices (minimum bid price is known as floor price and maximum bid price is known as cut-off price) that a company offers to the investors, investors can bid any price between the price band offered. |
Listing gains | When any IPO lists at the price more than the bidding price, the gain enjoyed by the investors is known as listing gains |
Allotment | When the applied shares are credited to the investor’s D-mat account, it is known as an allotment. Generally, allotment is made within 10-15 days after bidding. |
Depositary participant (DP) | DP refers to the agent or the stock broker which serves as a mediator between investors and depositories (CDSL and NSDL). Some popular DPs are Groww, Kite by Zerodha, Upstox, Angel one, etc. |
Investment banks/ Underwriters | They serve as a mediator between security issuers and the investors, they help them in going public and also help them in achieving minimum subscription, i.e 90%. Some popular investment banks are Morgan Stanley, Goldman Sachs, etc. |
Issue size | It refers to the amount of money a company is raising from the general public by launching its IPO, issue size= total number of shares offered in IPO * value of each share. |
Conclusion
Here, we are at the end and we have read everything about an IPO in detail, we had covered topics: what is IPO, Types of IPO, How to invest in IPO, The process of IPO, How to analyze IPO, etc. We are all set to invest and earn a good amount of profits from IPOs.
FAQs:
Q1. Can I bid for 1 single share in the Initial Public Offering (IPO)?
Ans. No, you can’t bid for the exact amount of shares rather you can bid for lots, a lot is a unit that contains a particular number of shares decides by the IPO raising company, anyone who wants to bid in an IPO can either go for a single lot or multiple lots, based on his/her investor category.
Q2. Is it confirmed that I will get an allotment after bidding?
Ans. No, it’s not compulsory that you will always get allotment in Initial Public Offering (IPO) after bidding, it’s your luck.
Q3. Is investing in IPOs a good option?
Ans. Yes, investing in IPOs is a good option to earn handsome profits, but you must do proper research before investing, as it can give you losses also if lists at a price lower then your bid price.
Q4. What is the difference between DRHP and RHP?
Ans. DRHP stands for draft red herring prospectus, it is a document prepared by companies who want to raise capital through IPOs, it is a draft of RHP which is prepared and sent to SEBI to get approval, if SEBI makes any objection in DRHP then it has to be corrected by companies and then prepare a new document which is termed as RHP (red herring prospectus).
Q5. After how many days of bidding an allotment is made?
Ans. Generally, within 10-15 days of bidding, the final allotment of shares is made, a person who is selected for allotment will receive his/her allotted shares directly into his/her D-mat accounts on the allotment date.
Q6. Do I get my bidding money back if I am not selected for the allotment of shares?
Ans. Yes, your full amount of money will be refunded back into your respective bank account. As per the current guidelines of SEBI, a refund will be initiated within 4 days if you are not selected for allotment.
Q7. What is the difference between IPO and FPO?
Ans. IPO stands for initial public offering and FPO stands for further public offering, when the company raises capital from the general public for the first time then it is known as Initial Public Offering (IPO), and on the other hand when any company who is raising capital from the general public but not for the first time, is known as FPO.
Q8. How per share price decided in Initial Public Offering (IPO)?
Ans. If any company wants to go public then the first step is appointing an investment bank, this investment bank prepares all the documents on behalf of the company and estimates the company’s current valuation, and based on its valuation each share price is decided.