- What is an IPO?
Initial Public Offering (IPO) can be defined as the process in which a private company or corporation can become public by selling a portion of its stake to the investors. Through the IPO, the company gets its name listed on the stock exchange.
Before the IPO, a company has very few shareholders. This includes the founders, angel investors and venture capitalists. But during an IPO, the company opens its shares for sale to the public. As an investor, you can buy shares directly from the company and become a shareholder.
- Why does a Company offer an IPO?
To raise capital for growth and expansion
Every company needs money to increase its operations, create new products or pay off existing debts. Going public is a great way to gain this much-needed capital for a company.
Allowing owners and early investors to sell their stake to make money
It is also seen as an exit strategy for initial investors and venture capitalists. A company becomes liquid through the sale of stocks in an IPO. Venture capitalists sell their stock in the company at this time to reap returns and exit from the company.
A company going public means that the brand has gained enough success to get its name flashed in the stock exchanges. It is a matter of credibility and pride to any company. This is a great way for a company to publicise its products and services to a new set of customers in the market.
- Types of IPOs
- Fixed Price Offering
Fixed price offering is pretty straightforward. The company announces the price of the initial public offering in advance. So, when you partake in a fixed price initial public offering, you agree to pay in full.
- Book Building Offering
In book building offering, the stock price is offered in a 20 percent band, and interested investors place their bid. The lower level of the price band is called the floor price, and the upper limit, cap price. Investors bid for the number of shares and the price they want to pay. It allows the company to test interest for the initial public offering among investors before the final price is declared.
- Benefits of Investing in an IPO
· First-mover advantage
This is especially true when reputed companies announce an IPO. You get a chance to buy the company’s shares at a much lower price. This is because once the company’s shares reach the secondary market, the share price may go up sharply.
· Listing gains
When a company gets listed on the stock market, it may be traded at a price that is either higher or lower than the allotment price. When the opening price is higher than the allotment price, it is known as listing gains.
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- Process of Applying for an IPO
Nowadays, it has become easier to apply for an initial public offering because of the online application process. However, if you are a new investor, you need to learn a few things before applying.
The first important thing is funding. Whether it is a fixed price or a book building IPO, you will have to make a payment in advance, and for that, you must have funding ready. Investors can use their savings or take a loan from a bank or NBFC for the purpose.
However, without a DEMAT account, you can’t invest in stocks. So, the next thing you need is to open a DEMAT account. Select a reputed broker with atrack record to have a DEMAT.
You can use the DEMAT account not only for IPOs, but to receive all sorts of investment instruments like gold bonds, corporate bonds, shares, and more.
The online process is an easy way to apply. You can do it from the investor portal on the broker’s website or by downloading the ASBA form from your bank’s net-banking platform.
ASBA stands for Application Supported by Blocked Account (ASBA). It allows banks to block funds in the applicant’s account against your bidding for the IPO.
If you apply through the broker, you need to use UPI enabled payment gateways to make payment. In either case, cheques and demand draft payments are not accepted for bidding.
An investor needs to bid while applying for the shares in an IPO. It is done according to the lot size quoted in the company’s prospectus. Lot size can be referred to as the minimum number of shares that an investor has to apply for in an IPO.
A price range is decided and the investors require to bid within the price range. Though an investor can make a revision in his biddings during an IPO, it should be noted that he needs to block the required funds while bidding. In the meantime, the arrested amount in the banks earns interest until the process of allotment is initiated.
There are different investor categories when it comes to IPOs. This includes:
- Qualified Insititutional Buyers (QIBs)
- Non Institutional Investors (NIIs)
- Retail Individual Investors (RIIs)
The allocation of shares differs for all the above groups in an IPO. As an individual investor, you come under the last category.
As an individual investor, you are allowed to invest in small lots worth Rs 10,000-15,000. You can apply for a maximum of Rs 2 lakh in an IPO. The total demand for shares in the retail category is judged by the number of applications received. If the demand is less than or equal to the number of shares in the retail category, you are offered a full allotment of shares.
When the demand is greater than the allocation, it is known as oversubscription. Many times an IPO can be over-subscribed five times over. This means that the demand for shares exceeds the supply by five times!
In such cases, the shares in retail category are offered to investors on the basis of a lottery. This is a computerised process that ensures impartial allocation of shares to investors.
- Terminology Associated with IPO’s
Draft Red Herring Prospectus
The DRHP is the document that makes the public know about the company’s IPO listings after the approval made by SEBI. A DRHP contains the following information about the company:
- Purpose of raising funds through listings
- Balance sheet
- Promoter’s expenses
- Earning statement of the last three years (if applicable)
- Net proceeds of the company
- Commission and discounts of the underwriter
- Details such as the name and address of all the underwriters, officers, directors and stockholder who possess 10% or more than the currently outstanding stock.
- Legal opinion on the listings
- Copy of the underwriting document
- An underwriter can be a banker, financial institution, merchant banker or a broker. It assists the company to underwrite their stocks. The underwriters also commit that they will subscribe to the balance shares in case the stocks offered at IPO are not picked by the investors.
What is IPO grey market?
An IPO grey market is one where a company’s shares are bid and offered by traders unofficially. This takes place before the shares are even issued by the company in an Initial Public Offering (IPO).
Since this is an unofficial market, there are no rules and regulations. Market regulators like Securities and Exchange Board of India (SEBI) are not involved in these transactions. The regulator doesn’t endorse this either.
Grey markets are generally run by a small set of individuals. All deals are based on mutual trust.
Grey Market Premium
Grey market premium is nothing but the price at which the shares are being traded in the grey market.
For instance, let’s assume the issue price for stock X is Rs 200.
If the grey market premium is Rs 400, it means that people are ready to buy the shares of company X for Rs 600; (i.e. 200+400).
This is how a typical deal works out in the grey market.