The Indian stock markets have witnessed a series of successful IPOs (Initial Public Offerings) in recent years. With a number new of IPOs lined up for this year, there is a lot of buzz among retail investors waiting to invest in IPO.
Although it is a common belief that every newly listed share will continue to appreciate, it is a wise option to evaluate the merits of each IPO separately. The following sections will tell you the meaning of IPOs as well as everything to know before subscribing to one.
What Is an IPO (Initial Public Offering)?
IPO is the process of raising capital from the stock market by issuing shares to investors for the first time. In other words, IPOs involve an unlisted company turning into a listed entity by offering its shares in the primary market, a market dealing with new securities. After listing, people can freely trade a business’s shares on the stock exchanges.
Private/public companies can raise funds for their upcoming projects or expansion through IPOs. A company gets a fair valuation of its worth as it gets listed on the stock exchanges.
While some consider all upcoming IPOs an opportunity, you should remember to take precautions as they carry certain risks. So, you may want to assess every new IPO and only subscribe to stocks of companies with sound fundamentals and reasonable prices.
How Do IPOs Work In India?
A privately-held company can become a publicly-traded entity through an Initial Public Offering. In India, companies have to abide by the IPO process when offering their shares to the public.
The following points will cover how IPOs work:
- To open an IPO, a company first needs to hire investment bankers to make an underwriting document.
- These experts will conduct a detailed analysis of the firm to decide all terms of the IPO, including offer size, allocation, and price.
- They will also help to prepare a DRHP (draft red herring prospectus) to register for an IPO. This is an offer document that a company needs to file to the Securities and Exchange Board of India (SEBI) and the registrar of companies. A company also needs to file its DRHP with the Securities and Exchange Board of India (SEBI).
- A DRHP contains all necessary details about a company, including its ongoing projects, promoters, objectives of the IPO, terms of the issue, financial details, risks, opportunities, threats, etc. Investors can take a look at this document to decide if they want to invest in a upcoming IPO.
- The capital markets regulator SEBI will verify all disclosures and approve the IPO if it fulfils all the eligibility criteria. The company can then announce a date for this IPO and look for the green signal from stock exchanges (NSE or BSE) to float the public issue.
- The next step is roadshows, which are presentations for large institutional investors to promote an IPO. Finally, this business will announce the IPO opening date, price band, and allotment date to each investor category.
Eligibility Criteria for IPOs in India
SEBI has laid down several rules for companies to meet certain eligibility criteria to launch an IPO. These are discussed as follows:
- The company must have net tangible assets of at least Rs. 3 crore in the last 3 years.
- 50% of its net assets must be in cash or cash equivalents.
- It must have a net worth of at least Rs. 1 crore for the last 3 years.
- Its total issue size must not be over 5 times this company’s net worth.
- A company must have at least Rs. 15 crore in average operating profits in 3 out of 5 previous years.
Besides the SEBI regulations, the National Stock Exchange of India (NSE) and the Bombay Stock Exchange (BSE) also have set up certain prerequisites for IPOs. These are as follows:
- The corporation’s paid up equity share capital must be Rs. 10 crore or higher.
- Its capitalisation of equities must be at least Rs. 25 crore.
- NSE requires companies to submit all financial reports for 3 previous years.
- The firm must not have a negative net worth.
- It should have never been referred to the National Company Law Appellate Tribunal (NCLAT) or National Company Law Tribunal (NCLT).
What Are the Various Types of IPOs in India?
These are the common types of IPOs in India:
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Fixed price offering
In a fixed price IPO, a company, along with its underwriters, decide the price of the initial share sale. They figure out the price of IPOs by evaluating the company’s assets, liabilities and other financial data. The price of these IPOs remains fixed and is unaffected by market demand.
Investors can know about the stock’s demand only after the issue closes. A benefit of this IPO is that its fixed price could be lower than the market value. This would result in profits if investors later revalue the company positively.
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Book building offering
In a book building IPO, there is no fixed price but a price band. The company, along with investment bankers, decide on a price range considering its financials, prevailing market conditions and the success of its roadshow. The lowest price is the floor price, while the highest price is the cap price.
In the case of this type of IPO, the quoted price must be within the price band. The company decides the price of stocks after evaluating all bids. Thus, investors get to know the IPO’s demand on a daily basis.
What Are the Components of an IPO?
The following are the components of an IPO?
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Fresh issue
In the case of a fresh issue, a company issues new equity shares. It sells those newly issued shares to retail and institutional investors. The proceeds from the fresh issue flow directly to the company, and it is a crucial source for to raise funds needed for growth and expansion. Earnings per share fall when a company raises funds from the fresh issue of equity shares.
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Offer for Sale (OFS)
In an OFS, the promoters and existing investors of a company aim to sell their shares through the IPO. OFS makes it easy for existing shareholders of the company to exit their investments in a transparent manner.
Setting up a pure OFS does not involve a lot of paperwork and auditing. Another difference from other types of IPOs is that OFS takes one trading day.
What Is the Need for Companies to Launch IPOs?
While IPOs are an opportunity for the general public to buy shares of a company, it is also a way for early investors to exit their position. In the early stage of a business’s life cycle, the owner raises funds from friends, family, and angel investors. When a company goes public, these original investors may want to sell their holdings.
Companies can use IPOs to infuse fresh capital into their business. The capital raised can be used for various purposes, including:
- Paying expenses for research or a new R&D initiative
- For capacity expansion or product diversification
- To enter a new geographic region
- Carrying out mergers and acquisitions
- Paying off existing debt (partially or fully)
Another reason for launching an IPO is that it may be a cheaper option to raise capital compared to bank loans, private investors or venture capitalists. Moreover, listing on the stock exchanges provides considerable publicity for the company.
An IPO also brings a great deal of scrutiny to a company’s affairs. Analysts from around the world report on the company’s financials, latest developments and investments. However, it brings a great deal of attention and credibility.
Types of Investors Who Can Invest in an IPO
IPOs are open to all sorts of investors, whether large financial institutions or everyday investors. These investor categories have a certain reserved quota out of the total issue size.
The following are the various categories of investors who can invest in IPO:
- Qualified Institutional Buyers (QIBs): This investor category consists of large institutions registered with SEBI, such as commercial banks, insurance companies, fund houses, etc. An IPO can reserve up to 50% of the issue size for these investors.
- Non-Institutional Investors (NIIs): NIIs are retail investors who are willing to invest more than Rs. 2 lakh in an IPO. Both resident and non-resident Indians (NRIs) can apply via this category. NII bidders have a minimum 15% reservation in any IPO.
- Retail Individual Investors (RIIs): All investors who are willing to invest up to Rs. 2 lakh in an IPO are retail investors. IPOs must reserve at least 35% of the issue for RIIs. Retail investors are allowed to bid at the cut-off price.
- Anchor Investors: Anchor investors are QIBs willing to invest at least Rs. 10 crore through the book building process. IPOs can allocate up to 60% of the QIB reservation to anchor investors.
Benefits of Investing through IPOs
Here are some of the benefits of IPO investments:
- Listing gains: Many investors find IPOs attractive for the chances of making profits when the shares are listed. Let us say that you have purchased shares via an IPO, and the shares list at a higher price on the stock exchanges. In that case, you can sell off the shares to get listing gains.
- Affordable share prices: The price quoted by a company when launching an IPO is often the lowest price for buying the shares of the organisation, and you may get them at a discounted price. If the company becomes successful, its stock price may become unaffordable for you.
- High transparency: There are stringent norms for IPOs that make it mandatory for corporations to disclose certain information. The company has to reveal information with regard to its performance, financials, future plans, etc.
- Meet long-term goals: Historically, equity investments tend to generate higher returns than other asset classes. An IPO benefits you by letting you pick winning stocks at an affordable price. If you remain invested for the long-term, you increase your wealth and fulfil your financial goals.
- Better chances for small investors: SEBI has made it mandatory for companies to allocate a certain portion of IPOs to retail investors. Thus, a great benefit of IPOs is that small investors get a fair chance to participate in the primary markets.
How Does IPO Allotment Work in India?
An IPO remains open for 3-5 days, and investors can put in their bids for shares during this time. Once the IPO closes, the IPO allotment process takes place. This is described as follows:
Companies announce a lot size for IPOs, where the total issue is divided into lots with an equal number of shares. You can place bids for multiple lots and not in terms of shares. Once all bids are placed, a system process is operated to eliminate all improper applications.
The IPO allotment process depends on its subscription, i.e. whether the number of bids is less or more than the shares offered in an investor category. If the IPO is undersubscribed, everyone will receive shares for the bids they put in. For oversubscription, SEBI has established some rules about allotting shares.
If the public issue has a small oversubscription, every bidder will receive at least one lot of shares. Then, the bidders will get the rest of the shares based on their bid offer. However, in the case of a very large oversubscription, it may not be possible to assign a lot to everyone. In that case, the distribution will take place based on a computerised lucky-draw system.
How to Invest in IPO Online?
You can place your order for an IPO through a bank that offers the ABSA (Application Supported by Blocked Amount) facility. SEBI has mandated the use of this facility to apply for an IPO. When you use ABSA, the amount for purchasing shares remains blocked in your account till you are allotted shares.
Now let’s find out the different ways to invest in IPO
Through internet banking
Step 1: Log in to your internet banking account.
Step 2: Go to the Investments section and find the IPO option.
Step 3: Enter the depository and bank details for verification.
Step 4: Select the name of the IPO in which you want to invest.
Step 5: Now, type in your bid price and the number of lots you want to purchase. Click on Confirm/Submit to place your bid.
Through your broker
Step 1: Log in to your brokerage account.
Step 2: Navigate to the IPO tab and select the name of your preferred IPO from the list.
Step 3: Input the lot size and the bid price.
Step 4: Enter your UPI ID and approve the transaction on your bank’s app.
Step 5: Click on the ‘Submit’ button.
Final Word
IPOs offer some of the biggest opportunities to create wealth. To make financial gains by subscribing to IPOs, you will need to spot a winner and enjoy the gains of investments. Before invest in IPO, make sure to assess all risk factors and do adequate research to make an informed decision.
Frequently Asked Questions
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Are there any eligibility criteria for investors to apply for an IPO?
Yes, there are some simple eligibility criteria you need to fulfil to apply for an IPO.
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- You need to be above 18 years of age.
- You will need to have a PAN card.
- Having a Demat account and a brokerage account is mandatory.
- Your bank account must be linked with your Demat account and have a sufficient balance.
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What are the essential things to look for before invest in IPO?
The following are some factors to consider before applying for an IPO:
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- The information available about the company
- Its purpose for raising capital
- The company’s current debt situation and its potential growth factors
- Risks involved with your investment
- If there is any mandatory lock-in period
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Can a company launch an IPO multiple times?
No, an IPO is meant for a company to raise funds from the public for the first time. However, companies can open a follow-on public offer (FPO) to raise additional funds from the public. In a dilutive FPO, companies issue more shares to raise capital, whereas, in a non-dilutive FPO, holders of the privately held shares sell their stakes to the public.
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Who are the key parties that a company appoints for an IPO?
The following are some key parties in an IPO:
- Merchant bankers: A company requires one or more merchant bankers to ensure compliance regarding the IPO process
- Registrar: For accepting application forms, processing them and issuing refunds
- Auditors: Auditors are responsible for auditing and restating the issuer’s financial statements for the DRHP
- Legal counsel: To ensure due diligence on Indian laws for the IPO
- Designated intermediaries: Entities responsible for collecting application forms for the IPO
Others include sponsor banks, advertising agencies and monitoring agencies.
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Are there any risks associated with an IPO?
Yes, when you are invest in IPO, you need to deal with some risks. Even if a company has potential for growth, there is no guarantee of its future success. So, you will want to review your risk appetite for the IPO. Your age, financial situation and your current liabilities will affect this decision.
Before invest in IPO, you will need to look at various risk factors like the company’s debt situation, ongoing legal proceedings, market-related risks, risks arising due to policy changes, etc.
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