If you are looking to diversify your portfolio and expecting gains on stocks of emerging companies, IPO might have caught your fancy.
Investing in IPOs can potentially give a good upside. But, before going for one, it is important to cut all the noise, speculation and hype. And do a thorough research on the company to understand the current business and future prospects.
If you are just beginning to invest, you might have many questions. What is an IPO, really? How is IPO trading different from ordinary stock trading? What kind of risks does it entail?
Fret not, we have got you covered.
First things first, what is an IPO?
IPO stands for Initial Public Offering. This means a privately held company invites the public to buy its shares for the very first time. The price of these shares can either be prefixed or fixed later on after gauging their demand. This process of issuing an IPO is commonly referred to as “going public.”
Did you know?
The first recorded company to go public was VOC, popularly known as the Dutch East India Company. It was established in 1602 as a chartered company whose goal was to trade with Mughal India.
Now, why do companies want to go public?
Before buying an IPO, investors need to understand why the company has launched an IPO and what it intends to do with the raised capital.
Here are a few common reasons:
1. Reduce the cost of capital
Companies might need to raise additional capital for multiple reasons and through different stages. For example, to expand the business, fund research and development, launch new products / services or enter new markets, etc.
Raising it through IPO reduces the cost of capital.
2. Credibility and boosting public image
The buzz around IPO helps the company boost its public image. It also opens doors for profitable mergers and acquisitions, or even loans from financial institutions on better terms.
3. Diversification
A company might be planning to acquire a similar company as a part of its growth strategy. It can help strengthen the core company, diversify its offerings, and eventually raise its stakes in the industry.
Types of IPOs
There are two common types of IPOs.
1. Fixed Price Offering
In this case, the company decides a fixed price for its shares which are going to be offered to the investors. The price of shares decided will be revealed to the investors before the company goes public.
2. Book Building Offering
In case of a Book Building Offering, the main objective is efficient price discovery of the shares being issued, and giving the issuer maximum price.
This price is determined by considering the demand of shares. Here, bids are collected at various price bands that are higher or equal to the floor price. Floor price is the minimum price at which investors can bid for the shares in the IPO.
The offer price is determined after the bid closing date.
Things to consider before you buy an IPO
1. Plan long-term
IPO is the time when the shares are rolled out for the first time. So you get the perfect opportunity for early stakes and can leverage it according to your long-term goals, like retirement planning.
2. Read the prospectus
At the time of IPO, the investors are offered a draft red herring prospectus (DHRP). You can study all the data related to the company, right from its financial standing, performance to its promoters and competitors.
3. Due Diligence
Before investing in an IPO It’s important to remember that there is no guarantee that a stock will continue to trade at or above its offering price once it starts trading on a public stock exchange.
Many companies have debuted with high estimation, only to struggle and go out of business within a few years. So, it is very important for retail investors to do research and due diligence.
Finally, how to get started with an IPO?
You would need the following:
- Demat account
- Trading account
- The mobile number linked to the bank account
- UPI ID
1. Log in to the trading app or terminal of the broker and go to the ongoing IPO section. Select investor type and IPO to apply for. Enter the number of shares and bid price. UPI id must be entered as well.
2. Once the application is submitted after entering all the necessary details, a mandate request is sent on the UPI application for approval. The applicant must log in to the UPI application and accept the mandate request. Once it is accepted, the amount for the IPO is blocked.
3. After allotment, the amount blocked will be deducted from the bank account.
In case of oversubscription getting the allotment will be based on sheer luck and if shares are not allotted to you then the amount blocked will be unblocked automatically.
Our two cents:
Remember to do comprehensive research before you invest, and take all recommendations with a pinch of salt.
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FAQs
What does oversubscription mean?
When the number of buyers is greater than the number of shares available for the initial offering.
What is red herring prospectus?
It is also known as DRHP (Draft Red Herring Prospectus). It provides details about an investment offering to the public.
DRHP contains:
- A summary of the company’s background and financial information
- The name of the company issuing the stock
- The number of shares
- Type of securities being offered
- Whether an offering is public or private
- Names of the company’s principals
- Names of the banks or financial companies performing the underwriting
What is underwriting?
Underwriting is the process through which an individual or institution takes on financial risk for a fee. This risk most typically involves loans, insurance, or investments.
The term underwriter originated from the practice of having each risk-taker write their name under the total amount of risk they were willing to accept for a specified premium.
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