In this era of Bumper listing IPO frenzies and crazy capital gains through IPOs of unicorn startups, it’s obvious to wonder what’s an IPO and how it exactly works.
The objective of this post is just that; to explain everything you need to know about Initial Public Offering, aka IPO.
What’s an IPO?
IPO is a way for a Private company to offer its shares to the general public in exchange for their investment in the company, thus, turning a Private company into a Public Company.
Thus, the full form of IPO is Initial Public Offering.
In other words, once a privately owned company goes through an IPO, it is no longer a private company. Now the public shareholders also have a say in the company and the company has to share its earning reports, profits, and other relevant news with the public.
Before the IPO, a private company has only a few shareholders including initial investors like family & friends, angel investors, VCs, Private Equity Firms. Once a company goes for an IPO, the general public and other institutional investors can directly buy shares from the company through its Initial Public Offering.
Why do companies go Public?
There can be several reasons for a company’s decision to go Public. Companies usually go public after already raising money from other kinds of private investors like Angel Investors, Venture Capital firms (VC), Private Equity Firms (PEFs), and Banks.
Companies, in essence, go public to avoid debt and raise investment without the need to pay finance charges which often means better profitability.
When a company goes public it is effectively spreading its risks among a large public (investors).
Some of the other advantages for a company to go Public are:
- Raising capital. This can be for many purposes including, expansion of the business, product range expansion, debt repayment, cash flow etc.
- Provide an strategic exit opportunity for its initial private investors. IPO is a great profitable opportunity for long term invested initial investors in the company. IPO provides opportunity for these investors to exit with good premium price on it’s debut on the exchange.
Once the company is listed and SEBI’s required lock-in period (6 moths as of Aug 2021) is over, these initial investors can decide to stay invested, sell partial holdings or sell all of their holdings. - Opportunity to gain more eyeballs on the company. The companies that apply for an IPO usually get a lots of eyeballs and become a subject of talk among investors and general public. This creates greater interest among public and thus have a positive impact on the company’s growth.
- A public company can raise more funds in the future via secondary offerings because it is already listed on the public markets.
IPO Timeline
To be eligible to offer a company’s shares to the public, a private company has to meet several requirements and go through various strict steps laid by SEBI (Securities and Exchange Board of India).
- Selecting a Merchant Banker or Investment Bank
Investment Banks basically take care of all the IPO documentations and formalities ranging from ensuring legal compliances, representing the company, Drafting Red Herring Prospectus, underwriting shares, book building to road shows.
I realize some of these terms might be new to you, I’ll explain these terms later under Key IPO terms. Keep reading. - Getting approval from SEBI. The merchant banker(s) submit a registration request to SEBI with all relevant information and objective for the IPO.
After going through this statement, SEBI takes the approval decision about the IPO. - Creating a Red Herring Prospectus.
Red Herring Prospectus is a document which provides detailed information about the IPO including:- Important dates
- Estimated size of the IPO, how many shares are being offered, and expected share price range
- Fund utilization timeline explaining how the company plans to utilize the raised capital
- Business details including expenses, revenue model and risks involved in the business
- Financial records
- Future prospects and plans for the company growth
- Details about the management and related contact information.
- Stock Exchange Approval.
Stock Exchanges have a listing department which makes sure the company applying for listing follows exchange’s listing criteria. These listing criteria include: minimum issue size, minimum market cap etc. These criteria are dependant on which Stock Exchange the company is applying for listing. - Subscription phase
Once all the above formalities are done, the company can offer its share to the investors.
The investors can bid for the IPO on the dates specified on the Red Herring Prospectus. One can apply for the IPO through their trading broker terminal. The bidding amount is blocked on Investor’s bank account as mandate till the allotment process gets completed. - Allotment of shares
Once the bids are collected and matched in the books, the shares are allotted to the investors based on the demand and price quoted in their IPO applications.
Most of the IPOs get oversubscribed, meaning there are more bids than the amount of shares offered by the company. In this case, the shares are allotted fairly by computer program that picks investors randomly and allots shares in a fair manner. Thus, in case of oversubscribed IPO, investors might get partial quantity allotted to them and some investor might not get any allotment. The allotted quantity of shares are credited to investor’s Demat Account. In case of partial or no allotment, the bid amount gets refunded to their bank account. - Listing day
The last step in an IPO is listing of the company on the Stock Exchange. Once the above mentioned steps are successfully done, the company gets listed generally within 7 days once the shares are allotted.
Once the company gets listed, its shares can be traded everyday among investors and new investors can buy shares from old investors.
Note: An individual investor can apply for a maximum of ₹2 lakhs in a particular IPO. A single lot of IPO shares costs between ₹10k and ₹15k.
How to invest in an IPO?
There are two things you will need to invest in an IPO: A Demat Account – to store your shares, and a Trading account – to trade (buy/sell) shares.
You can invest in an IPO via a Broker or via your Bank Account that supports ASBA (Application Supported by Blocked Amount).
ASBA (Application Supported by Blocked Amount) is a mandatory requirement by SEBI. When you apply for an IPO the total bidding amount is blocked on your Bank account for the IPO. The majority of Banks support ASBA, but not all.
To apply for the IPO, log in to your Bank Account or Broker terminal and go to the IPO section.
Click on the company name whose IPO you are applying for.
Fill the IPO application form with details including personal details, Demat Account details, your Bid amount, quantity, and UPI id/Bank Account number.
Submit the application form.
For a complete guide check out: How to apply for an IPO | Step by step guide.
Open a Demat + Trading Account here on Zerodha.
Benefits of investing in an IPO
- Listing gains. When the company gets listed, the price of the stock can drastically move up or down depending on the market’s enthusiasm for the company. When the trading price on the listing day is higher than the allotment price, this gain is known as Listing gain.
Usually the investors looking for quick profit are most excited about listing gains. They usually sell their shares when they get good enough listing gain. - High Returns. Most long term investors see it as an opportunity to earn high returns. When you are investing in an IPO of a strong company with a potential to grow, you stand a good chance of earning high return in long term when the company grows.
- Benefit of being first. When applying for IPO of a reputed company, you are essentially getting a chance own its shares at a lower price. That’s because usually when these reputed companies get listed on the secondary market, the price may soar sharply.
Okay, so we have learned so far what actually is an IPO, how it works, why and how to apply for an IPO. In case few terms didn’t make sense while reading, here is a glossary of few key IPO terms.
Key IPO terms
Issuer. The company or the firm that wants to issue its share to the public through the IPO is referred to as an Issuer
Issue Price. Also known as Offering Price, is the price at which the shares will be issued to investors before the company gets listed and starts trading on the Stock Exchange.
Lot size. The smallest number of shares you can bid for an IPO is called the Lot size. The number of shares you bid for must be in multiples of the lot size decided by the company.
Underwriter. The Underwriter is essentially the investment bank or merchant banker that manages the offering for the issuer. The underwriter is responsible for the whole IPO from determining the issue price to the allotment of the shares. The underwriter also commits that they will subscribe to the remaining shares after the final allotment of the shares to the public (in case of under-subscription).
Depending on the size and needs of the company, an issuer can appoint more than one underwriter.
Oversubscribed & Undersubscribed. An IPO is called oversubscribed if the number of Bids received is more than the number of shares on offer.
On the contrary, if the Bids received are less than the number of shares on offer, it is called an undersubscribed IPO.
Greenshoe option. Also known as the overallotment option, allows the issuing company to issue more shares (typically 15%) in case of oversubscription to the IPO.
Red Herring Prospectus. It’s a document that is published by the IPO company and drafted by the underwriters appointed by the company. This document shares with the readers/investors all the information about the company, which includes the company’s business model, financial statements, earnings report, business risks, dates related to IPO, info about the management and underwriters, and contact info.
Price band & Cut-off price. The price range, comprising of minimum and maximum price, in which the investors are allowed to bid for the IPO is called the price band. This price band is decided by the company and its underwriter(s).
The price at which the shares are issued to the investors is called the cut-off price.
Flipping. The practice of reselling the issued shares in the first few days of the listing on the secondary market is known as Flipping. Flipping is practiced by investors for earning quick profit and is usually done when the stock is discounted and the price soars on the listing day.
Primary market & Secondary market. The company is said to be trading on the primary market when it is in the IPO phase (bidding and issuing). Once the company gets listed and starts trading publicly on the stock exchange, it is said to be trading on the secondary market.
Conclusion
IPO is usually a win-win event for both the issuing company and the investors. The company gets the investment and all the press around its IPO. The investors get the chance to earn a good return in the long run, given that they chose a fundamentally strong company after doing due diligence on their side. Most investors try to apply for every IPO but, in my opinion, it makes more sense to apply for the ones which make more sense to you based on your analysis of the IPO company.
That being said, good luck with your IPO investments. Hopefully, the entire article was helpful to you.
Let me know in the comments which IPOs you are applying for.
