Initial Public Offering(IPO) is an offer of new shares of a private company to the public for the first time. Ownership changes hands – from being entirely privately held, the company is now giving ownership to the masses. Not every company can afford to raise enough money from private investors. Also, going public presents other benefits than just raising capital. As an investor, you stand to make extremely high returns on your investment if you pick the right IPOs. The IPO process is complete and strictly monitored by the SEBI.
Also read: IPO List, current-ongoing-listed IPOs
The need for IPO
- Easy access to huge capital is the foremost reason companies choose to offer shares through IPO. There’s no money quite like money from the masses.
- Listing in a stock exchange adds credibility to a company – which comes in quite handy in a range of scenarios. The company is expecting to be accountable to its hundreds (and thousands) of shareholders and is therefore perceiving as responsible.
- An IPO helps gauge public sentiment towards the company’s prospects. Also, it offers an exit route for private investors who can now sell off their shares at huge profits or just see their net worth rise manifold as the shares gain in value.
- It gives the company valuable leverage while negotiating loan terms, interest rates on loans, mergers, or acquisitions. With loans, listed companies can get capital at a lower cost, that is, at a lower rate of interest. Mergers or acquisitions are facilitating so that valuable company shares can be made part of the trade deal.
Criteria for filing IPOs
The following are the eligibility norms for companies planning to file an IPO as stipulated by SEBI.
- The company should have had net tangible assets (defined as physical assets plus monetary assets of at least 3 crore rupees in each of the last three years. Doesn’t include virtual assets with a fluctuating value like shares)
- The company should have had an operating profit of a minimum of 15 crores for at least three years in the preceding five years.
- The size of the IPO can’t exceed the company’s worth by more than five times.
Even if these criteria are not fulfilling, the company can still file a request for approval of an IPO with SEBI. But, for such approvals, the IPO can only take the book building route where 75% of the stock must sell Qualified Institutional investors (QII). This is must for the sale of stocks under the IPO. Otherwise, the IPO will cancel and the capital will return.
SEBI functions to protect the interests of investors while ensuring that norms aren’t too stringent to dissuade prospective companies that have the potential and the vision to deliver growth.
Initial Public Offering (IPO) Process Overview
- A private company decides to raise capital through an IPO.
- The company contracts an underwriter, usually a consortium of investment banks that assess the company’s financial needs and decide the price/price band of shares, the number of shares to be offer, etc.
- The underwriter then participates in the drafting of the application (to SEBI) for approval with details of the company’s past financial records including profits, debts/liabilities, assets, and net worth. Also, the draft mentions how the funds are using.
- SEBI carefully scrutinizes the application and after making sure that all eligibility norms are fulfilling, it gives the company the go ahead to release the ‘red herring prospectus’.
- The ‘red herring’ prospectus is a document releasing by the company mentioning the number of shares and the issue price/price band (price of one share) to be offering in the IPO. It also has details of the company’s past performance.
- In what is a ‘Road show’, executives travel to meet with and woo potential investors to buy their company’s shares.
- An IPO opens and can last for 3-21 days, though it is usually open for 5 days.
- During this time, retail investors can bid for stocks through their banks/brokerages via the Internet. Learn how to buy IPO.
- Investors need to have a Demat account to participate in an IPO, and a PAN card.
- If the stocks you bid for are allotting, they will credit to your demat account. If not, you’ll get your money back.
Types of IPOs
- Fixed Price Issue
- Book Building Issue
Fixed Price Issue
In a fixed price IPO, the Company along with their underwriters evaluate the companies’ assets, liabilities, and every financial aspect. Then they work with these figures to fix a price per issue to achieve the target funds. This price which is fixed per issue is printed in the order document. The order document justifies the price with qualitative and quantitative factors. we can know the demand for securities only after the closing of issue. The oversubscription levels are high in the fixed price offerings, sometimes several hundred times.
Book Building Issue
Compared to the developed countries, the concept of book building is new to India. In the book building issue, the price is discovered during the process of IPO. There is no fixed price, but there is a price band. The lowest price in the band is referring as the ‘floor price’ and the highest prices refer to the ‘cap price’.
The price band is printed in the order document. And the investors can bid for the desired quantity of shares with the price which they would like to pay. Depending on the bids, the share price is deciding. The securities are offering above or equal to the floor price. The demand is known every day as the book is built.
|Book Building Issue||Fixed Price Issue|
|Reservations||50% Of Allocations Are Reserved For The QIBs. 35% For Small Investors And The Rest To Other Categories Of Investors.||50% Of The Allocations Are Reserved For Investments Below 2 Lakhs, And The Rest For High Amount Investors.|
|Demand||It Can Be Known Every Day.||It Is Known Only After The Close Of Issue.|
|Payment||The Payment Can Be Made After The Allocation||The Payment Should Be Done 100% In Advance. Refund Is Given After The Allocation.|
|Pricing||The Exact Share Price Isn’t Fixed. Only The Price Band Is Fixed. The Price Is Fixed After The Closing Date Of The Bid||The Share Price Is Fixed On The First Day Of Issue And Is Printed In The Order Document.|
IPO is one of the most important things that every investor should know. many beginners and investors apply for IPO. but never know the background of the IPO. in this post we discussed Initial Public Offering and its importance. i hope this post will give a basic idea about the Initial Public Offering.