All you need to know about an IPO

Deepika Chelani
Updated: 17 Jan 2022, 12:06 PM IST
TL;DR.

Initial Public Offering (IPO) is the medium through which private companies go public. It is a good opportunity for the investors as the shares are made available at a fair valuation and there is the scope of earning great returns on the same.

An IPO is a procedure by which a private company declares itself as public by offering its stocks for the first time to the public.

An IPO is a procedure by which a private company declares itself as public by offering its stocks for the first time to the public.

Initial Public Offering (IPO) enables the transformation of a privately-held company into a public company. Initial Public Offerings (IPO) can at times be the golden goose for many as they have the potential to bring high returns. It gives rise to an opportunity for smart investors to earn an attractive return on their investments. The article aims to address all the questions that arise with regard to an IPO.

What is an IPO?

An initial public offering (IPO) is a method through which a private business identifies itself as public by offering its stock to the public for the first time. A firm can raise equity capital by issuing stocks to the public in an initial public offering, or existing shareholders can sell their shares to the public without generating any new capital. Through this way, the company's name is placed on the stock exchange and its stocks are made available for the investors.

What are the different types of IPO?

IPOs can be broadly categorized into two types:

Fixed Price Offering

The price under this IPO is evaluated by the company with the consultation of its underwriters. The company’s assets, liabilities, and other financial aspects are evaluated before the underwriters fix a price for the offerings. This price is fixed only after taking into consideration all the qualitative and quantitative factors.

The prices are generally undervalued during the company’s IPO. The prices of a fixed price offering issue are mostly lower than the market value. This helps in keeping the investors interested which leads to a positive revaluation of the company. The prices of the shares under this IPO are fixed on the very first day of the listing and are printed in an ordered document.

In a fixed price offering IPO, the demand is revealed only after the issues are closed. Also, the payment for this IPO is made at the time of bidding and the investor needs to pay 100% price of the share at the same time.

It is important to note that 50% of the total allocations in the fixed-price offerings are reserved for investments below Rs. 2 lakhs in the Indian context. The rest of the allocations are reserved for high amount investors.

Book Building Issue

This type of IPO has a price band or a price range instead of a fixed price. It is relatively more efficient. The lowest price of the band is known as ‘floor price’ and the highest price is known as ‘cap price’. An investor can begin by bidding for the shares by quoting his/her price that he/she would like to pay. The price of the stock is fixed later once the bids are evaluated after the closing date.

The company initiating a book building issue IPO offers a 20% price band to the investors on the stocks. The investors are required to specify the number of shares they wish to buy and the amount they intend to pay per share. The demand for shares is known after each day and the payment for a book building issue can be completed after the allocation.

In a book building issue IPO, 50% of the total allocations are reserved for the QIBs, 35% are reserved for small investors and the remaining 15% is allocated to other investors.

Note - It is important to note that the number of fixed-price issues is greater but the capital accumulated from the book building issues is far greater than that of the fixed price issues after the market price corrections are incorporated.

It can be concluded that IPO is majorly of two types, Fixed Price Issue and Book Building Issue. The price of the offering in a fixed price issue is evaluated in consultation with the underwriters and is taken into account after assessing all the qualitative and quantitative factors. A book building issue has a price band instead of a fixed price and it is relatively more efficient.

Before we dive into the more intricate details of an IPO. Let's understand the cycle of an IPO from the surface.

What is the cycle of an IPO?

Coming up with an IPO is an extensive process for the company and it follows a cycle of events.

Stage 1 - The process begins with hiring an investment banker or bankers depending upon the size of the company. They are responsible for underwriting the issue along with managing the entire process. In order to ensure there are no legal problems, the company also hires lawyers well versed in this field.

Stage 2 - This is the official step of coming up with an IPO. The company submits a registration statement to the Securities and Exchange Board of India (SEBI). The statement is expected to be a reflection of the financial health of the company along with its business plans. The detailed financial records of the company are thoroughly scrutinised.

Stage 3 - With the assistance of the investment bankers, the company begins to draft its draft red herring prospectus (DRHP). The DRHP mentions in detail the business plans, location of offices and plants, and financial performance along the expected price range of the IPO. The document is a detailed manual of the company for potential investors.

Stage 4 - In order to garner the interest of the investors, the investment bankers take up ‘road shows’. These are visits to imminent commercial centres, corporates, and individuals with a very high net worth. The investment bankers of the company pitch their idea and present the company’s growth potential to attract heavy investments.

Stage 5 - The company receives approval from SEBI as soon as the market regulator has reviewed the statement of registration and the background check of the company looks satisfying to SEBI. The company is allowed to release its DRHP for the investors only after it receives a permit from SEBI. SEBI might suggest some modification in the prospectus. Once the changes are accommodated, the prospectus is fit to be released. This is also the stage at which the company makes a decision about the choice of the board on which it would list its IPO.

Stage 6 - Although the DRHP mentions a tentative price band, the company comes up with a final price band only after receiving approval from SEBI. If the company takes up fixed price IPOs then the final price of the IPO is announced by the company for the investors. In the case of a book-building method, the price is revealed at a later stage. Along with the price band, the company also finalises the size of the IPO. After announcing the price band, investors are invited to bid for the shares in the multiples of lots.

Stage 7 - Once the price band and the size of the IPO is decided, the date of the issue is revealed. On the given date, investors can bid for the shares of the respective company.

Stage 8 - The share-allotment is the next stage of the IPO cycle. The bids are analysed by investment bankers in order to make a decision about the cut-off price. The demand for the IPO determines the cut-off price. Mostly the IPOs are oversubscribed, therefore the shares are allotted in proportion to the bids made by the investors.

Stage 9 - The final stage of the cycle involves the listing of the shares on the stock exchanges. The investors who are allotted the shares receive it in their Demat account, others who are not eligible are returned their money.

The IPO cycle looks like an extensive process but it should be noted that the major tasks are done by the company, the investors only need to be very careful while going through the prospectus. Placing bids should be done carefully in accordance with the price band, size of the IPO, the financial health of the company, and its future plans of growth.

How does an IPO work?

In the form of an IPO, a company's equities are issued to the public for the first time. A company that offers a public issue gets listed on the stock exchange and obtains funding through an initial public offering (IPO) for debt repayment, capital expenditure and to provide an exit path for its core investors. It not only benefits the company financially but also improves the company’s brand equity.

Private firms can obtain equity capital through IPOs by issuing new shares to the public, giving retail and institutional investors a chance to participate in the offering and to become shareholders of the company. The cash raised is then used by the firm for expansion and growth, while the investors can earn profit from their investment.

Working of an IPO

The company employs underwriters to guide them in evaluating the financial aspects of the company. They carefully examine all the factors including the assets and liabilities of the company and decide the number and the price or the price band at which the shares should be offered. Underwriters also provide their assistance in drafting the application to SEBI to seek their approval for the issuance of IPOs.

The draft sent to SEBI contains all the financial information of the company including their net worth, assets, liabilities, etc. The company also mentions the details on how they plan to allocate the funds collected through the selling of securities in the application.

Securities and Exchange Board of India (SEBI) carefully goes through the application submitted by the company. All the contents of the application including legal and financial factors, plan of utilisation of the funds collected are examined by a group of experts. If no errors are found, the SEBI allows the company to release the draft red herring prospectus(DRHP)

The ‘red herring' prospectus is a document issued by the firm that specifies the number of shares and the issue price/price band to be offered in the first public offering. Following the filing of the DRHP, the firm determines the price range in which it wants to go public. It is one of the most important phases in the entire process since it determines whether the deal will succeed or fail.

The firm formally opens the window to the public and makes the shares available. Following that, investors file IPO applications indicating their desire to purchase the shares. The business assigns the shares to the investor once the subscription window closes.

The final step in the procedure is to list it on the stock exchange. The shares are eligible to be traded on a daily basis on the secondary market once they are issued to the public in the primary market.

Before a company goes public, it usually takes care of a few factors. It makes sure that the industry environment is supportive of the IPO debut, and also that the company's overall growth is promising. Furthermore, the timing of the IPO is also critical, and collision with other IPOs is avoided.

Why do companies go public?

A firm gets elevated to the status of a public limited company from a privately held enterprise when it sells its stake to the public. The major reason for a company's IPO is to raise capital. The entire process of selling shares is referred to as a "public offer." Investors also have the chance to become shareholders in the firm and take a share in its earnings.

Apart from selling public stock, a business has numerous other alternatives for obtaining cash, such as borrowing, venture capital investment, and so on, to cover future operating expenditures or considerably extend its growth potential. Why does a firm choose to go public?

Let us list out the reasons due to which a private firm might become public-

To improve the credibility of the company

The companies need to abide by the guidelines laid by the Securities and Exchange Board of India before issuing their public offering on the Stock Exchange. As the company undergoes this process, it clears the financial holdings of the company and makes them transparent. The public believes that the company has been approved by SEBI and hence, its credibility in the market increases.

To liquidate existing stakeholder’s investments

Usually, a private company has limited investors and as the business grows, the investors earn profit. But, the reputation and fame earned by the company can be monetized only after the company goes public. Because the prices of the shares, during bidding, go up, if the investors have a good name for the company. Therefore, going public helps the existing investors to increase their profits and liquidate the investments made by them.

To introduce fresh capital into the company

A private company generally relies on its investors and shareholders to finance the expenses required for the growth of the company. Sometimes, the funds from the existing investors are not sufficient in comparison to the amount required. In that case, the company can either go to the banks for loans, but the rate at which the bank is willing to provide a loan, may not be feasible for the company. Another option is to sell the shares of the company to the general public. This option is considered to be a more cost-efficient way to generate funds.

To boost market visibility

Sometimes the investors may be unaware of the presence of the company. When the public offerings are advertised and launched, it gains attention from the public. The investors start exploring and analysing the financial aspects of the company. This increases the market presence and in return might boost up the business and growth of the company.

Going public can help private companies realise their full potential in the future. Because the stock market is driven by investor sentiment, a company with strong foundations can reap a slew of benefits by going public. Getting listed by a company is traditionally seen as a sign of growth, which helps to bolster its image in the minds of investors.How does a firm issue an initial public offering (IPO)?

The company employs an investment bank to manage the IPO before it goes public. In the underwriting agreement, the firm and the investment bank collaborate on the financial transaction specifics of the IPO.

They then file the registration statement with the Securities and Exchange Board of India along with the underwriting agreement. The SEBI thoroughly examines the given material, and if it is deemed to be correct, it sets a date for the IPO to be declared.

How is an IPO valued?

IPO valuation is the method through which a group of analysts calculates the appropriate value of the shares of a company. The value of a company's initial public offering (IPO) is the price attached to each share before it gets listed on the stock exchange. The company that decides to go public hires investment bankers who devote a significant amount of time and effort in determining its value.

Process of valuation of an IPO

Investment bankers are employed by the firm to assist them in analysing the company's financial factors. Company executives, along with them, carefully consider all parameters, including the company's revenue collection and its assets and liabilities before deciding on the number of shares to be issued and the price or price range at which they should be sold. After the approval from SEBI, a final ‘Red Herring' prospectus is issued and is listed with the stock exchange. Then the value of the IPO is determined.

What are the factors determining the value of an IPO?

Certain factors such as the demand for the company’s shares play a role in the valuation. By and large, the following factors determine the IPO’s value:

  • The current trends in the stock market
  • The company's financial record in the past few years.
  • The company's prospective growth rate
  • The business model followed by the company
  • Demand from potential consumers for the stocks
  • The prevailing price of shares of similar firms in the industry
  • Number of shares to be issued

What are the different approaches used while determining the value of an IPO?

The process of valuation of an IPO is a demanding one and requires a systematic procedure to be followed. Generally, two approaches are navigated while calculating the pricing of an IPO. These are the Absolute Valuation Approach and the Relative Valuation Approach.

Absolute Valuation Approach

The current value of a firm or organisation is estimated in an absolute valuation method by predicting future income sources via Discounted Cash Flow (DCF) analysis. This computation is accomplished with the help of the firm's financial statements and accounting records to determine the value of the company. The company's future cash flow is projected using DCF analysis, which then is discounted to the firm's present value to obtain the absolute value.

Relative Valuation Approach

The firm's value is compared to that of its industry competitors in a relative valuation approach in order to determine the company's financial potential. Here, the worth of the company is estimated using ratios, benchmarks, and averages wherein the benchmarks can be adjudged by conducting a wide industry analysis. This method may also be used by investors to determine whether a stock is worth buying.

In a nutshell, while determining the price of an IPO, it is more important to consider the company's valuation rather than the price of a single share. The share price is impacted by a number of variables after it is listed, namely economic circumstances and overall market perception. The shift in the share price is then indicated by a comparable change in the company's valuation.

However, an IPO is similar to any other investment wherein investors are expected to do their analysis before committing any funds. A smart initial step is to go through the prospectus and financial statements. Getting influenced by the media coverage and rumours may not be a good idea.

How is the IPO price determined?

There are two types of IPOs, and the issue price is determined based on the type of the IPO.

Fixed Price Offering

In a fixed-price IPO, the price of the issue is decided by the company itself. The company, with the help of its underwriters, estimates the financial aspects of the company while deciding the issue price. Once the order is printed, the price is made public and the floor is open for the investors to buy the securities.

50% of the allotment is set aside for investments of less than 2 lakhs, with the remainder reserved for high-value investors. In this process, the market demand of the stocks can be determined only after the issue is closed. Hence, the issue price does not depend on the demand of the stocks.

Book building Offering

In book building IPO, the price of the issue is decided as the investors bid for the shares of the company. The company publishes the price band in the order document wherein the upper limit is known as the cap price and the lower limit is known as the floor price. The investors bid for prices according to the price band.

50% of allotment is reserved for the Qualified Institutional Bidders (QIBs), 35% for small Investors, and the remainder for other Investors. In this process, the market demand of the stocks can be determined every day as the bidding goes on.

IPOs attract a lot of media interest, some of which are intentionally fostered by the firm that is going public. IPOs are popular among investors in general because they create dramatic price fluctuations on the day of the IPO and immediately thereafter. This can sometimes result in huge gains, but it can also result in large losses. IPOs are generally considered a good option for investors who have detailed knowledge about the companies offering them.

What is the function of IPOs in an economy?

A number of Initial Public Offerings issued at a time explains the condition of the economy and the stock market. As during the recession, not many investors consider it worthy to invest in stocks as the stock market itself goes down during recession and depression time periods.

While if IPOs see a boom in their bidding then it can be concluded that the economy is in the repairing mode and the economy is churning again and it’s fruitful to invest and the economy has a wide range of opportunities at the moment.

What is the cut-off price in an IPO?

The price at which the shares get issued to the investors is referred to as the ‘cut-off price’ in an IPO. It is called ‘issue price’. If an investor is applying at the cut-off price, he/she will have to pay the highest price while placing the bid. The cut-off price is decided by the company after consulting the book running lead managers (BRLMs). The cut-off price falls within the price band.

Eligibility for bidding at the cut off price

Those eligible to bid at the cut-off price include Eligible Employees under the Employee Reservation Portion, Retail Individual Bidders (RII), and Shareholders Bidding under the Shareholders Reservation Portion (subject to the Bid Amount being up to 200,000).

Anchor investors, Non-institutional bidders (NII), Shareholders Bidding under the Shareholders Reservation Portion (for the bid amount above 200,000), and Qualified Institutional Bidders (QIB) are not eligible for bidding at the cut off price.

However, it is advised to read the IPO prospectus document in order to check the eligibility criteria before bidding.

Let’s understand the cut off price with a simple example:

When an investor selects to bid at the cut-off price, it implies that he/she is willing to bid at the issue price which is determined by the Merchant bankers after receiving all the applications.

Explaining it with an example, suppose the price range for an IPO is fixed between Rs. 200 and Rs. 205. Now, an individual applies to bid 10 shared at Rs. 202. Further, the determining issue price by the company turns out to be Rs. 201, the individual shall receive the allotment at Rs. 201 since he/she was willing to avail the issue up to Rs. 202.

However, if the determined price of the issue turns out to be Rs. 204, then he/she will not receive the allotment of the shares. On the other hand, if an individual selects ‘cut off price’ while applying, then he/she will be eligible for allotment at any price determined for the issue.

To conclude, to bid at "cut-off" will ensure that the retail investor gets an allotment. The allotted quantity will depend upon the demand made at various price points.

How to Track Latest and Upcoming IPOs?

Initial Public Offerings are offered to the public in order to generate funds for expansion, growth, mergers, acquisitions or paying debts and liabilities which can be bought by both individuals and institutes.

Whenever there’s a release of a new Indian IPO, the market as a whole is in a rush and investors usually await for quality stocks, but it is always advisable to research about the company beforehand and list down all pros and cons before investing in a particular company.

Knowledge about the market and economy also plays a crucial role for investors while applying for IPOs, but an investor should also gather information about the balance sheets, debts, future plans, past performance, etc of the company before investing.

Let's have a quick look at some options from where an investor can keep track on upcoming IPOs:

Exchange Websites

Websites like BSE, NSE post updates about IPOs on a regular basis, and the information posted is bound to be more reliable than others. It is always advisable to check multiple such websites simultaneously for better understanding and research. Prospectus of the companies offering IPOs can also be downloaded from these websites, and all the information regarding the company can also be found for general awareness of the investor.

The only drawback of these websites is that before putting up the information the same is checked and verified multiple times which does cause delay but still is considered the most reliable source for the update and tracking.

Google

Google is the most used search engine all over the world, which can provide information on every topic possible. Google is comparatively easier to use as you can find the information you want from different websites with just one click, because of which research work becomes easier.

Google also has a feature where the user can streamline the type of news the consumer needs to consume which can be very efficient and fruitful for investors who are trying to keep track and stay updated about IPOs. It’s also beneficial to use Google as it is not only restricted to Indian IPOs but if the investor wants to keep track of stocks from all over the world as well.

Financial Newspaper

Financial Newspapers are also a great source for keeping a track over IPOs, as they print up-to-date information with market analysis and personalised opinions which help in understanding and making the decision of investment.

The newspapers are available in both hard and soft copy, and always cover IPOs of prominent companies with proper analysis and market reactions. They are a reliable source for research point of view as well, as intellectual editors write these analyses.

IPO Calendar

As the name suggests, many websites and platforms have IPO calendars that state dates and months for the upcoming IPOs in a particular year. It is very beneficial and easy to keep track of and also gives enough time to investors to research the company and invest with the proper knowledge for the same.

It is very important to keep a track of stocks as it gives an edge to the investor and keep them informed about the market and the stock they will be investing in. It is advisable to have a thorough knowledge before investing as more and more people have started investing in the market, and IPOs are limited in number which should drive the investor to make more informed decisions.

How to find a good IPO to invest in?

Initial Public Offering floods the stock market, which creates a panic among the investors as the decision of investing in a particular company becomes difficult with so many options. Here are some pointers that can be kept in mind while evaluating companies for investing in their IPOs.

Business Strength

It is considered important to go through business models, finances, management stability, and previous performance of the company before investing in their IPO. Every company that plans to go public issues a red herring prospectus which can be beneficial for the investor to know about the company a little better.

Invest only if you’re convinced that the company can be trusted and have strong attributions for the upcoming future. Research about a company's position in the market and future endeavours can also influence the decision of the investment.

Company with Strong Brokers

Investors should be extra cautious while looking out for brokerages, try to look out for companies that have strong underwriters. It is often said in the stock market world that quality brokerages are likely to go for the quality.

Investors need to remember that smaller brokerages will be willing to underwrite any company. Good big companies do not allow the investor’s first investment to be an IPO, usually, those who get IPOs are long-standing and high-paying players of the stock market.

Promoter’s Intention

It is always important to see how much stocks are being diluted by the promoter’s group before investing in the IPO. If the promoters are diluting their stocks often it can infer that they have less confidence in the company or have thought of shutting down.

A management’s intentions can be judged by looking at what they are drawing from the company, if the company is giving fat remuneration and large dividends to its management, then there is a point to suspect about.

Be Cautious

Scepticism is always appreciated in the world of the stock market and while deciding which IPO to invest in. It is necessary to be cautious while investing in an IPO considering the uncertainty is high in the stock market and the level of information is less and difficult to understand by a layman.

It is also important to note that an average investor doesn’t usually get IPOs for good companies as brokers pre-save those lots for big players, so the research about companies should take place accordingly.

Pricing

The brand name of a company cannot always be a distinguishing factor for selection in IPOs. A lot of times big multinationals over-price their stocks making the investor reconsider their decision of investing in the particular company.

To estimate the price of the stock, a competitive analysis can be done. Price-to-Sales and Price-to-Earning are the commonly used ones. But it is also true that some companies overprice their IPOs as they are genuinely better than their competitors. Thorough research of the past and future endeavours can tell a lot about this perspective.

With technologically friendly resources picking, tracking IPOs has become an easy task. It can be concluded that investors with sceptical thinking and a knack for research have proven to be successful in the field of the stock market and choosing the appropriate company for the IPO.

What does the DP name mean in an IPO application?

It is imperative to have a demat account, a trading account, and a bank account in order to invest in the stock markets. The demat account is run by the depository, the trading account is operated by a depository participant (DP) or broker and the bank is responsible for operating the bank account.

The money is transferred from the bank account to the trading account by the investor to buy shares. After this, the actual transaction takes place through the exchange and the demat account is used to credit specific securities for the money invested by the investor.

Since the securities are in electronic or dematerialized form, they cannot be transferred to a physical locker. The securities that change hands on the stock exchange are stored by the depositories. They are the vault that keeps the securities but is not involved in direct engagement with the investor or the companies issuing the securities. There are two major depositories in the Indian context:

National Securities Depository Limited (NSDL)

Central Depository Services (India) Limited (CDSL)

Advantages of a depository system

A depository system makes the process of participating in the capital market easier and hassle-free. It enables the dematerialization of the securities which leads to a paperless share market, unlike the older days.

The ease of exchange is another important advantage of the depository system. Dematerialization makes it possible to identify the securities of the same class which in turn improves interchangeability. This helped in lowering the actual cost of exchange and boosted the speed of trade.

The depository system has also ensured that the transfer of securities between depositories is conducted through a secured electronic system and there is no extra cost levied for the transfer. Though the final settlement takes 2 days more than the day of the trade, the transfer of the shares happens immediately.

Depository Participant (DP)

The entities that are registered with SEBI are allowed to act as a link between the depositories and investors are known as the depository participants. It includes institutions like banks and brokers. In other words, it is the agent or the registered stockbroker of a depository (NSDL, CDSL). A person registered under Section 12 of the Securities Exchange Board of India (‘SEBI’) Act, 1992 is defined as a depository participant according to the Depositories Act, 1996.

Stock Brokers with a minimum net worth of Rs. 3 crores are eligible to be registered under NSDL and those with a minimum net worth of Rs. 2 crores are eligible to be registered under CDSL.

DP Name

The name of the broker registered as the depository participant with SEBI is filled in the box for DP name. Along with the DP name, the ID of the depository participant is also mentioned. This ID is assigned to the DP by the depository that he/she is registered with. It has been observed over the years that typically the first eight digits of the Demat account form the DP ID.

Filling out an IPO application becomes easy with the knowledge of the roles and responsibilities of the depository and the depository participants. Further, this also ensures that the investor is not scammed by a fake party acting as a depository participant.

What is Face Value in an IPO?

The fixed value of the share that is decided by the company when it opens an IPO is known as the face value of the share. The face value is also known as the par value or the nominal value of the share.

The face value is listed in the books and share certificates of the company as the original value of its stocks. It is used as a parameter to analyse the market value of stocks, returns, premiums, etc. It is important to note that the face value does not change, it is always fixed.

How to determine the face value?

There are no one particular criteria for deciding upon the face value of a stock. The companies assign the value in an arbitrary manner. The value is either Re. 1, Rs. 2, Rs. 5 or Rs. 10. At times the face value can also be Rs. 100 but it rarely rises to Rs. 1000.

The issue price is a sum of the face value and the premium. The company determines the premium after analysing its success metrics like earnings, revenue, and expansion.

What is the usefulness of face value?

Face value becomes an essential tool while calculating the market value of the shares, interest payments, returns, and premiums. Additionally, face value is employed while announcing a stock split. This can be understood with an example.

Suppose the share price of a firm rises to Rs. 5000 with a face value of Rs. 10. It would become very difficult for the retailers to invest Rs. 5000 in a share. Therefore, the company can split the share into 5 shares which increases the liquidity. Post the split, the face value comes down to Rs. 2 and the price of the share reduces further to Rs. 1000 from the previous Rs. 5000.

Another important use of face value can be seen when companies announce dividends. Companies use the face value instead of the share price in this case.

For example, when a company announces 100% on a share with a face value of Rs. 2 and a share price of Rs. 200, the dividend is calculated on the face value. Thus, the dividend will equal Rs. 4 per share.

Understanding the concept behind face value ensures a clearer understanding of the major business announcements made by the companies. It also enables the investors to make more informed decisions.

How to apply for an IPO?

To be able to apply easily for an IPO, the investors need to have the following three accounts.

  • Bank account- The amount of the shares of IPO are paid from the bank account.
  • Demat account- The shares are kept in digital form in a demat account.
  • Trading account- A trading account can be opened via a brokerage firm and is necessary to apply online for an IPO.

How to apply through UPI?

  • Open your trading account.
  • Select the IPO you wish to apply for.
  • Specify the number of shares you wish to buy.
  • Mention the price at which you wish to buy the shares.
  • Fill the application form carefully as asked.
  • Allow the request to block the funds in your bank account.
  • Your application is submitted.

How to apply through the ASBA facility?

Application Supported by Blocked Amounts or ASBA facility allows the investor to block the amount mentioned by him in the application without actually withdrawing it. This facility can be availed generally through all the banks. Here are the following steps:

  • Open your bank account online through net banking.
  • Choose the IPO you wish to apply for from the list of available IPOs.
  • Specify the number of shares you wish to buy.
  • Mention the price at which you wish to buy the shares.
  • Enter other necessary details. Some details such as the PAN number will be prefilled and cannot be edited.
  • Allow the request to block the funds in your bank account.
  • Your application is submitted.

How to apply Offline?

  • Collect the application form from your broker or it can be downloaded from the NSE website.
  • Fill all the necessary details including the price and the number of shares you want to bid for.
  • Submit the duly filled application form to your bank.
  • So, an investor can apply for an IPO via any of the three options available based on their convenience and familiarity: UPI or ASBA, or offline process.

How to bid for an IPO?

Before bidding for an IPO it is important to know that all the IPOs are not the same. IPOs are classified into retail, high net worth individual (HNI), and institutional categories. It is the retail category that is open to the general investing public. An investment of up to Rs. 2 lakh is classified as retail.

Secondly, it is imperative to know the difference between a fixed-price IPO and book building IPO. In a book-built IPO, the company provides a price range and the bid falls in this range. The issue price is decided after the bids are received. 

The bidders who quoted a price equal to or higher to the issue price released by the company are eligible to the allotment of the shares. For the fixed price issue, the company sets a fixed price in advance and the investors can apply only at the given fixed price.

The stepping stone

Any investor who is interested in bidding must keep the research work ready with her/himself. Alternatively, sound advice from the broking firm in case of any doubts and confusion should also be considered. It is advised that an individual consults only authorised and reliable sources, beware of fake entities.

Make sure you have a designated bank account, a Demat cum trading account along with a depository participant, your PAN card, address proof, the ASBA form and other documents mentioned by the DP should be easily reachable.

Bidding Process

Each IPO puts out a ‘lot size’ that an investor needs to adhere to in order to subscribe to the IPO. The lot size mentions the minimum number of shares that must be purchased. Make sure you furnish the details in accordance to the lot size prescribed by the IPO. Additionally, ensure that your account has sufficient funds to support the purchase.

The next step is to choose your platform for bidding - either online or offline. An online IPO application is much easier and hassle-free. You can apply for the IPO listed at a stock exchange through the mobile application or the website. For the offline mode, you are required to carry all your documents to the local officer of the broking firm and then apply to the IPO of your choice.

The question that troubles a lot of people is, ‘at what price shall I bid?’

A potential investor can buy or sell at the cut off price. However, it must be noted that only retail investors are allowed to bid at the cut-off price. The possibilities of getting the allotment decreases manifold if the bid-price is lower than the cut-off price

It is advisable to bid at the cut-off price but the cut-off price is not determined while bidding, the bid should be submitted at the cap amount. You do not have to worry if the issue price comes out to be lower than the amount you bid, the variance in price is reimbursed after the allotment of the shares take place.

Bidding online is super easy, all the trading sites and the broking have an IPO page which enables investors to buy shares online. You only have to enter the number of shares you wish to bid for along with the price of the bid. Remember that you can make a maximum of 3 bids. Once your application is confirmed, you will receive the IPO application number and a receipt of the transaction details which will come handy during allotments.

The final wait comes to an end on the day of allotment of shares. Getting your shares depends on a lot of factors, there might be a possibility that you will get lesser shares than what you bid for. This is because the demand for the shares is generally higher than the actual number of shares.

If you receive lesser or no shares, the bank will release your blocked bid amount either in parts or all of it at once. In case you receive full allotment then you will be issued a Confirmatory Allotment Note (CAN) within six working days of the closing date of the IPO. After the allotment of the shares, they are directly credited to your demat account. From here, you may trade them when they get listed on the stock exchange.

It is very important to be well versed with the process of bidding an IPO as it ensures the investor remains protected from any kind of fraud or loss of money. In case of queries one should always approach the DP or the broking firm for clarification.

How are shares allocated in an IPO?

When a company issues an IPO, the interested investors file an application to buy the shares. These applications are easily available on NSE/BSE websites or can be collected from the banks. Most of the time, a large number of applications are received and hence the allocation of shares goes through a systematic procedure. 

It is commonly seen that not all investors are allotted the same number of shares in an IPO that they applied for. To understand the reasons for this, it's imperative to first know what a ‘lot size’ is.

What is the lot size?

The total number of shares that a company plans to issue are divided into a fixed number of shares known as ‘lots’ and the investors make their bids accordingly. For example, if a company decides to offer 1,000 shares with a lot size of 10 then, the total number of lots will be 1000/10 i.e. 100 lots. The investors will decide how many lots they want to bid for. The bidding cannot be done for shares less than a lot size, as per the guidelines laid by the SEBI.

Elimination Procedure

All the applications for the shares are registered online once a firm issues an IPO on the stock exchange. The erroneous applications that were entered improperly are then removed from the total number of bids using an online process. And hence, we receive the total number of successful bids for the given IPO.

In this case, there can be two situations-

  1. The final number of lots applied by all the investors is less than the total number of lots offered by the company.
  2. The final number of lots applied by all the investors is more than the total number of lots offered by the company.

The number of lots subscribed is less than what is offered

If the number of successful lots submitted by all applicants combined is less than or equal to the total number of lots offered then everyone is allocated the number of shares they had applied for.

The number of lots subscribed is more than what is offered

If the number of successful lots submitted by all applicants combined exceeds the number of shares available, then the share allocation procedure will require extra planning. According to the guidelines laid by the Securities and Exchange Board of India (SEBI), each person who has applied should get at least one lot.

Thus, the allocation of shares after an IPO is a rigorous procedure and its outcome relies on the number of times the issue was oversubscribed. And in the case of oversubscription, an investor subscribing to an issue stands to receive far fewer shares than they applied for.

How to check IPO allotment status?

As observed above, there are numerous instances when an investor does not get an allotment even after several trials. The first step in this direction is to check the allotment from a reliable source.

The IPO allotment status is a detailed manual that talks about the number of shares allotted to an investor in an IPO. The process of IPO allotment is executed by the registrar of the IPO. The status of the allotment is declared to the public through the website of the registrar of the IPO on the ‘IPO allotment date’.

The basis of allotment is also published by the Registrar in the form of a document. This document conveys the details about the allotments according to the number of applications that were received for the IPO.

The status of the allotment and calculation of the IPO allotment can be viewed online on the registrar’s website (listed in the next section). The investor can check his/her allotment status by entering the IPO allocation number or the PAN Number. Alongside, BSE, NSE, NSDL and CDSL also notify about the IPO allotment status via SMS and email.

Where to check IPO allotment status?

The website of the IPO registrar can be visited by the IPO investors to check the allotment status. The registrar of an IPO is a financial institution that is registered with the stock exchange and SEBI. The registrars are responsible for maintaining a record of the issues along with the ownership of shares of the company.

It is the responsibility of the registrar to allot the shares to the investors in an IPO, process the refunds for the investors who couldn’t get the shares and transfer the shares that are allocated to the investors to their Demat account. Each IPO has a designated registrar, these are KFIN Technologies, Link Intime India, Bigshare Services and Alankit.

The procedure to check your allotment for the desired IPO remains more or less for all the four mentioned sources. You are supposed to begin by visiting the website and then selecting the name of the IPO or the company. The next step would be entering necessary details like PAN number, DP ID, application number and all the other details that are asked.

What is the reason for not getting an allotment?

There can be various reasons for not getting the allotment. However, the three major reasons apart from the discrepancy in the issue price and bid price are listed below:

Your name was not probably picked up in case of a lucky draw which is undertaken in case of a very large oversubscription

The bid made by you was termed invalid and eliminated because of the incorrect Demat account number, multiple applications, incorrect PAN number, or an error with any other detail.

Another possible reason could be different PAN numbers for different accounts. If an individual uses different PAN numbers for the bank account, Demat account, trading account then the company cancels his/her bid

As per the new IPO allotment process brought in 2012, all the retail individual investors (RII) are treated equally. Under this system, applicants are allotted at least the minimum size of applications, this is however subject to the availability of shares.

What is the meaning of oversubscription in an IPO?

Oversubscription in an IPO is referred to as a condition when the number of shares applied by all the investors is more than the total number of shares offered by the company. This situation occurs when the demand for the shares exceeds the supply.

Let's assume a business issue an IPO and offers 10,000 shares to retail investors, and 1,000 applications are received for 50 shares each - the total demand is 50,000 shares, but only 10,000 shares are available. As a result, the offer was five times oversubscribed in the Retail Investor category.

How does this situation arise?

A company issues the offerings and interested investors file the application with the stock exchange.

After receiving all the applications, the incorrect and incomplete applications are eliminated through a computer scanning procedure. And then, the remaining applicants are assigned the shares subject to availability.

With regards to the number final of applications received, two situations can emerge-

  1. The final number of lots applied by all the investors is less than the total number of lots offered by the company.
  2. The final number of lots applied by all the investors is more than the total number of lots offered by the company.

The second case is known as oversubscription in an IPO and it requires a more systematic planning while allocating the shares.

What do SEBI’s guidelines say?

If an IPO is oversubscribed in the retail category, the shares must be distributed in such a way that every retail bidder receives at least one minimum lot, according to the SEBI standards. If there are any leftover shares, they are distributed proportionally among the investors who applied for more than one lot.

Types of Oversubscription

In the situation of an oversubscription, two cases are observed which are dealt with differently.

Small oversubscription

In the case of small oversubscription, the minimum amount of lots are assigned to all the investors who have applied for the IPO. After this, the remaining lots are distributed equally among the investors who had applied for more than one lot in the application.

Large oversubscription

This situation arises when the number of applied lots is much greater than the number of available lots and not even one lot can be assigned to each applicant. Here, the allocation of IPOs is done through the procedure of computerised lucky draw without any partiality.

Oversubscription of IPOs is a common phenomenon and hence, one should not expect the guaranteed allocation of the number of shares they applied for.

What is a Green Shoe option in an IPO?

Green Shoe option is a legal option of over-allotting shares included in an IPO by up to 15% in addition to what was initially planned. It was introduced by SEBI in 2003 and derives its name from an American shoe manufacturing company that was the first company to employ this clause into action.

The particulars of the allotment are specified beforehand in the underwriting agreement itself. Underwriters can utilise the green shoe option if the demand for the securities is higher than the expected demand and the sale price is higher than the initial offer price.

Why Green Shoe Option?

High Demand: When the demand for the shares of an IPO is high, companies seek this option to fulfil the demand of the investors by borrowing (buying back) shares from shareholders in order to raise additional revenue.

Reducing price volatility: The green shoe option is generally chosen by underwriters to stabilise the price and manage risk within the stabilising period i.e. 30 days from the release of the IPO. This provides a guarantee to the buyers that the price of the stock will not fall dramatically below the offer price.

How does the green shoe option work?

The green shoe option can be exercised by companies at the time of releasing its IPO. If the applications for shares are more than originally planned, the underwriter may over allot shares by a maximum of 15%. In the scenario when the market price exceeds the offer price the underwriter cannot buy back from the market without facing a loss. Then the underwriter buys extra shares from the company by exercising this option, at the offer price and covers out the extra share that it has allotted (covering its short position).

What are the types of greenshoe options?

Full greenshoe: As the name suggests full greenshoe option is when the underwriter utilises its whole option of buying additional shares. This happens when it is unable to buy back any share from the market and buys the shares from the company at the offer price.

Partial greenshoe: Alternately, when the underwriter buys back only a certain proportion of the shares that were over allotted before the price of the share rises.

Reverse greenshoe: If the sale price of the share falls below the offer price, the underwriter buys shares from the open market (thereby increasing demand) and sells them to the issuing company.

The greenshoe option is one of the first clauses that investors look for in an IPO prospectus. Commonly referred to as ‘over-allotment provision’ it is a great tool for underwriters to utilise for managing market volatility and making additional profits.

What is the role of an Underwriter in an IPO?

IPO underwriters are financial intermediaries, generally investment banks that specialise in the issuance and allocation of securities. Underwriters facilitate the company in the whole process of releasing its IPO by performing multiple roles simultaneously. These roles vary depending on the type of agreement that is signed between the company and the underwriter.

Many times depending on the size of the IPO, there can be multiple underwriters (called a syndicate) to diversify and distribute the risk of the IPO amongst the syndicate members.

The following are the key roles played by an underwriter:

Providing guarantee

There are many types of underwriter agreements that companies can sign with their underwriter. Most commonly underwriter agreements tend to guarantee that a minimum number of shares offered will be sold. Alternatively, underwriters guarantee a certain revenue by buying a proportion of shares themselves and further selling them to the public.

However, in some agreements such as a ‘best effort agreement’ underwriters do not guarantee the sale of any particular number of shares but strive to sell as many as they can.

Ensuring compliance & maximum profit

Underwriters render their expert advice to the companies during the valuation of securities. Underwriters try to ensure that the shares are neither undervalued (which leads to forgone profit) nor are they overvalued (which may lead to failure of the IPO).

They also have the responsibility to ensure due diligence and make certain that the IPO complies with all the requirements of the regulatory body like submitting fees on time, releasing necessary data for the public’s perusal, etc.

Publicising the IPO

The underwriter publicises the IPO by contacting a number of prospective buyers and mutual funds to attract investors and maximise the number of shares sold. In addition, underwriters also launch a marketing campaign for their companies by drafting a ‘red herring prospectus’.

Underwriting is one of the most important factors in the success or failure of an IPO. The underwriter plays a critical role in the whole process and carries a great responsibility. Because of the significance of this role and the complex execution process, many companies choose their underwriters on the basis of their reputation and prestige.

What are the risk factors involved in applying for an IPO?

Many companies choose to go public by releasing their Initial Public Offer (IPO) to raise capital and liquidate assets. In this process, a part of the company’s equity is offered for trading to the general public. While the company enjoys many benefits such as increased market influence and prestige after the launch of an IPO, there are many risks involved for the investors.

Let’s have a quick look into the top three risks of applying for an IPO.

Allotment of shares is not guaranteed

Applying for an IPO does not guarantee that the applicant will be allotted shares. This means that the returns are not assured. Even if the applicant is able to get some stocks it is possible that he/she may be allotted only a small proportion of stocks that they applied for. Since shares get allotted on a proportionate basis, small investors may not be granted any shares at all.

One of the reasons for this phenomenon is that before an IPO is actually released there is a pre-IPO placement reserved for big equity firms, hedges, etc. at discounted prices through which companies raise funds. The number of shares that will be offered to the public depends on how this process goes and how much equity the company has left to offer.

No history of how the shares will behave in the market

There is virtually no public data to predict how a company’s shares will perform after its IPO is released in the market. Another point worth noting is that even though going public a company is required to disclose all relevant details, it is sometimes quite difficult to determine what the loopholes might present in the company’s model and what market risks it bears.

Capital Loss

Sometimes it is possible that due to the hype around the launch of a company’s IPO the offered launch price of the shares might be inflated due to higher demand. Later, under normal market conditions, these prices tend to fall and the investors lose their money. Uber IPO is one of the most famous offerings to back this.

Alternatively, there is a risk of losing investment if the stocks of the company do not perform as well as expected or fall due to unfavourable market conditions (volatility risk). There is lingering uncertainty about the performance of equities. In addition, if the firm goes out of business, investors stand a chance to lose their whole capital amount (absolute risk).

Investing in an IPO is suitable for investors with a high-risk tolerance. Interested traders should thoroughly research the market conditions and familiarise themselves with the risks involved before coming to an ultimate resolution to avoid losing hard-earn money.

IPO vs FPO

When a business first starts out, it raises small amounts of money from venture capitalists and angel investors. As the firm grows, it will eventually need to obtain more cash in the form of stocks and debts.

The initial public offering (IPO) and follow-on public offering (FPO) are the two most common ways for a company to raise funds from the stock market. An initial public offering (IPO) is when a business generates cash for the first time by issuing shares to the public. On the other hand, FPO refers to when shares are offered for sale several times in a row.

They can be explained and differentiated on different parameters. But firstly, let us understand IPO and FPO in detail.

What is an IPO?

Initial Public Offering (IPO) is the process through which private firms or organisations sell some parts of their stake to investors for the first time to enable the firm to expand in the future. Through this transfer of stakes, a privately held organisation becomes a public organisation.

What is an FPO?

Follow-on public offering (FPO) is the process through which companies that are already listed on the stock exchange sell a part of their stake to the investors. This procedure is followed after the IPO. It is of two types - dilutive and non- dilutive. In dilutive public offering, share capital increases whereas it remains unchanged in the non-dilutive offerings.

 

There are generally two types of FPO:

Dilutive offering

A dilutive FPO occurs when a firm wishes to raise more money by releasing additional shares. This is done for a number of reasons which include to pay off the loans. In the situation of a dilutive FPO, however, a company's valuation remains constant, leading to a drop in the company's per-share earnings.

Non-dilutive offering

In Non- dilutive offering, the company's founders or major shareholders offer some of their stock to the general public. The money goes to the person who is trading the shares, not the firm. As a result, the company's profits per share are unchanged. They are also known as secondary market offerings.

What are the differences between IPO and FPO?

IPO vs FPO - Risks and returns

FPOs are considered less risky when compared to IPOs. IPOs are the first issue and investors are not well-acquainted with the financial prospects of the organisation whereas FPOs are considered a much safer option as the company is already listed on the stock exchange and the investors can have a detailed study about the shareholders, management and financial areas of the company. FPOs are generally the second or subsequent issue. IPOs, however, are expected to provide greater returns to the investors when compared to FPOs.

IPO vs FPO - Objective

The primary objective of an IPO is to maximise funds through investment by the general public.

The share capital in an IPO rises as the firm issues new capital to the public in preparation for its IPO.Whereas FPOs are generally issued for two reasons. Either to raise funds to clear off debts or to expand the business or to sell off shares privately held by individuals.

IPO vs FPO - Performance

In the case of an IPO, some Investors do not rely on the company's red herring prospectus. They subscribe to an IPO because of the company's market interest, management, and debt on the books, among other factors. Investors in this case have no information or experience with the firm.

Investors in an FPO have a track record of how the firm has fared and what market interest was like earlier. Equity stake sales may be a useful predictor of whether or not a stock is worth investing in.

To summarise, IPOs are riskier than FPOs and it is impossible to predict how an IPO would perform. As a result, it's critical to delve further into the company's prospects and fundamentals. In the case of an FPO, however, investors have a wealth of information about the firm. 

IPOs and FPOs, both have their respective advantages and disadvantages. Therefore, it depends on the investors that how much risk they are willing to incur and which offer suits them the best.

What is SME-IPO?

SME-IPO stands for Small and Medium Enterprise Initial Public Offering. It refers to the trading or exchange of shares in small and medium-sized businesses. SMEs are enterprises with sales, assets, or workers less than a certain threshold. The definition of a small business depends on the sector in which the enterprise operates.

In India, SMEs comprise a major chunk of the total available workforce and hence are an important part of our economy. Since the firms engaged here are small or medium-sized, the offering that opens is much smaller than those that are listed on the BSE and NSE's main exchange platforms.

In the year 2012, two SME exchange platforms i.e the BSE SME platform (BSE) and the EMERGE Platform (NSE) were launched. Besides the SEBI Guidelines for the listing of shares, the stock exchanges have their own eligibility requirements for the SME listing. As of now, over 300 businesses are now listed on the BSE, while over 180 companies are listed on the NSE Emerge.

How is SME-IPO different from the Regular IPO?

  1. A business that goes public through an IPO must disclose earnings quarterly, whereas an SME IPO needs to report bi-annually after the IPO.
  2. The minimum number of allottees allowed for an IPO is 100, whereas, for SME IPO, the same figure is 50.
  3. A conventional IPO requires a minimum investment of 12,000 to Rs15,000. SME IPOs, on the other hand, range from 1,20,000 to 1,50,000. This is due to the fact that only long-term and capital-intensive investors are permitted to participate in SME IPOs.
  4. The SME IPO application size cannot be less than 100,000, which is much more than a standard IPO application size of 10,000 to 15,000.

Eligibility criteria to issue offerings under SME-IPO

A firm can issue IPOs under the SME-IPO category only if it fulfils certain criteria laid by the SEBI.

  1. According to section 124 of the Companies Act, 2013, a company must be able to demonstrate that they have dispersed earnings in at least two of the previous three fiscal years.
  2. The post-issue capital should range between 3 crore to 25 crores and should have tangible assets amounting to a minimum of 3 crore as per the recent audited financial results.
  3. According to SEBI standards, the minimum trading bit for SME IPOs varies from 100 to 10,000, depending on the price band. These are evaluated and changed on a regular basis, based on the price fluctuation post the listing.

How to apply for SME-IPO?

Investors who wish to apply for SME-IPO can do it through an offline ASBA process. The online facility is not yet available for the same.

  1. Visit the nearest branch of the bank which provides ASBA facility. The investor needs to have an account in any branch of that bank to avail of this service.
  2. Collect the ASBA application form from your broker or it can be downloaded through NSE/BSE websites.
  3. Fill and submit the application form mentioning all the relevant details including PAN, account number, etc.
  4. Upon submission of the form, the bank will block the amount mentioned by the investor and forward it to the stock exchange for that particular IPO.

SMEs are critical for India's economic development and for creating job opportunities and thanks to the support from a plethora of investors, the Indian market appears to be favourable for SME-IPOs. 

Any IPO, whether SME or the conventional one, carries some element of risk. But the SME IPOs are relatively riskier. Before applying, the investors are expected to thoroughly research about the firm, its operations, financials, and other key factors.

What is the IPO grey market?

The unofficial market wherein individuals buy or sell IPO shares and applications even before they are officially launched for trading on the stock exchange is known as the grey market. Being an unofficial over-the-counter market, it has no regulations surrounding it.

The transactions in the grey market take place in the form of cash on a personal basis. Grey market is not backed by any of the third-party firms like SEBI, Stock Exchange or Brokers. Trading in the grey market is usually taken up by a smaller set of people because there is no official platform or set of rules that define this type of trading.

Does the grey market constitute a part of the IPO market?

The IPO market and the Grey market do not have any direct relationship. The IPO market is both official and organised in its conduct for raising funds in the market and functions as per the SEBI guidelines. On the other hand, the grey market does not have any guidelines circumferencing it.

The traders, however, offer shares and bid for the upcoming IPO in the grey market. These are more like the unofficial forwards on the shares and are not the actual shares of the IPO. The trades are majorly carried out over the telephone due to being an unofficial market. The grey market traders start bidding on an IPO before the company lists them. 

Various factors like retail appetite, the reputation of the promoters, institutional appetite, the possible extent of oversubscription, etc. are taken into account while bidding in the grey market. The prices are determined by demand and supply.

What does the grey market actually issue?

The grey market is viewed as an indicator of the performance of the stock once the company lists the shares. Investors and brokers give offers and bids at various prices for IPO stocks. The grey market largely runs on trust.

The retail investors, as stated above, view this market as an indicator of post-listing performance. On the other hand, the HNI investors view it as an indicator of the appetite for the stock which helps them to decide on how much to apply for when the IPO gets listed. The financiers are able to get an idea of whether financing the IPO would be a lucrative proposition or not.

What is the Kostak price and regulations?

The everyday word used for the price of the application is Kostak. Kostak rate is the price at which the applications are sold in the IPO market. Higher demand means a higher Kostak price. It is important to remember that the price in the grey market can fluctuate wildly as there is an absence of SEBI regulations.

The grey market is not guaranteed and thus an investor runs a counterparty risk while buying and selling in the grey market. The regulator generally discourages retail investors from trading in the grey market owing to the risk. The grey market is open to default by other markets, which makes it more like a forward market.

To conclude, the transactions in a grey market are forward transactions that are open to counterparty risks. It is advised to not take the grey market trades very seriously and the prices are subject to major manipulations.

What is the Grey Market Premium (GMP) in an IPO?

Let’s dive right into the concept of GMP in an IPO

The Grey Market Premium (GMP)

The premium that the investors are willing to pay over the issue price is termed as the Grey Market Premium (GMP). The price at which the shares are offered for sale before they are listed in the stock market is called the issue price.

GMP assists in measuring the interests of the investors in a particular IPO. It acts as a reflection of the performance of the IPO on the final day of listing. GMP of an IPO depends upon the demand and supply of the stock. How does this work? If the number of shares that have been offered in the IPO is greater than the subscription number of that IPO, then the GMP will be lower.

Understanding positive GMP

Suppose a company decides to offer a total of 1 lakh shares with the cut off price fixed at Rs. 250 after the bidding window closes. Now the subscriptions are a total of 1.5 lakh which is greater than the shares actually offered. Due to greater demand, the GMP is fixed at Rs. 100. It means that the investors in the grey market are willing to Rs. 350 (Issue price + GMP) for the company’s shares. This is an instance of positive GMP.

Understanding negative GMP

To understand negative GMP, let us consider a company offering 50,000 shares with a cut-off price fixed at Rs. 120 after the bidding window closes. The subscriptions that are received are 45,000 which is lesser than the actual number of shares offered. 

Due to less demand, the GMP is fixed at negative ( - )Rs. 50. This means the investors will be paying Rs. 70 ( Issue price + GMP) for the share.

GMP is regarded as a signalling mechanism for being a fair indicator of the demand of the IPO. However, the grey market is not an organised and regulated market, due to which the GMP can be manipulated.

There is a lot of buzz on social media around “trendy” IPOs that are launched. Let’s look into one such instance.

What is the LIC IPO?

In the Union budget 2021, Union Finance Minister Nirmala Sitharaman announced that the government would release the IPO for Life Insurance Corporation (IPO) this year. LIC is one of the largest corporations in India, so there are no prizes for guessing that its IPO launch would be the largest public offering ever in the history of Indian financial markets.

About LIC

LIC is the oldest, largest, and the only government-owned insurance company in India. It was established on September 1, 1956, by the Life Insurance of India Act. The company has close to 300 million policyholders and counting. Since its inception, the company has had a monopoly in selling life insurance in India and its name is used almost interchangeably with ‘life insurance’. Apart from life insurance, LIC has other businesses as well which include housing finance and investment, among others.

The IPO

The union budget 2021 focused on raising capital through disinvestment. The government aims to raise around 25,000 crore. Even though the government is expected to release only a minority stake of 5 to 7 percent, it will be one of the largest IPOs due to the sheer size of the company. 

Once LIC gets listed on a stock exchange, it will have to comply with SEBI’s requirements, enhancing its transparency and efficiency as it would be closely scrutinised. 

Existing policyholders will not be affected by the IPO and the Government of India’s sovereign guarantee will be maintained as per the current Life Insurance Corporation Act.

Individual investors can apply for LIC IPO through a broking firm or a bank that offers Application Supported by Blocked Amount (ASBA) service. One must have a DEMAT and a Trading account.

Process of application

To apply through your bank, login to net banking by signing in your details. After that select the IPO option and select the LIC IPO option from the list. Following that, you must enter the number of lots you want to bid for and the price of your bid.

You can also apply through your broker using the UPI mode of payment. To apply through your broker, log in to your trading account and select the IPO option for LIC. You have to enter the number of shares you are willing to bid for and enter the price of your bid. Complete the application by accepting the transaction on your UPI app.

The much-awaited public offering can be expected anytime in the latter half of 2021. Interested investors are advised to check their eligibility and bid for their desired number of shares after careful research and consideration of all relevant factors.

Understanding an IPO might appear daunting and due to the technical jargon. We have compiled a list of the most commonly confused words to make the process simpler for you.

IPO Jargon: Key terms used in an IPO

Investing in an Initial Public Offering (IPO) is a multifaceted process and all the investment documents are loaded with technical jargon. There are multiple risk factors involved in an IPO investment. 

Thus, it is recommended to familiarise oneself with the technicalities of an IPO through research. To facilitate this research we have mentioned some of the most commonly used terms in an IPO. Read ahead to find out what they mean.

Abridged Prospectus: The abridged prospectus of an IPO is the summary of all of its important details as specified by SEBI. The Companies Act of 1956 mandated all IPO application forms to be supplemented by an abridged prospectus. The abridged prospectus should not be confused with the ‘Red herring prospectus’ which is a preliminary registration document prepared by the company.

ASBA: Action Supported by Blocked Account (ASBA) is a mechanism developed by SEBI which ensures that the investor’s money is blocked in his/her account until the shares are allotted to him/her. It is meant to secure the investors’ interests by providing an alternative to the time-taking procedure involving refunds that was practised earlier.

Draft Herring Prospectus: A Draft Red Herring Prospectus (DRHP) is a registration document that contains information about the company’s finances, promoters, listed & unlisted peers, etc. At least 21 days before the official launch of its IPO, a company is required to submit a draft prospectus to SEBI. During this period the board reviews and suggests changes to the company. Additionally, the prospectus is also open to the scrutiny of the common masses.

Book Building Process: When a company chooses to launch its IPO through the book-building method, it follows the book-building process. In this process, securities are not valued at a fixed price but a price band is issued within which the investors can bid to decide the IPO’s offer price.

Offer date & Listing date: It is the opening date of an IPO starting when the investors can bid for shares. In other words, interested buyers can start applying for a particular IPO from its offer date. On the other hand, once the shares are allotted, stocks of the company are listed on the stock exchange for trading. The date on which they are listed is known as the listing date.

Lot Size: Lot size is the minimum number of shares that one can bid/apply for in an IPO. If one wants to bid for more than the minimum number of shares he/she has to do it in the multiples of the lot size. For example, The lot size of the Zomato IPO was set at 195. So, investors could bid for shares in multiples of 195 like, 195, 195 x 2= 390, 195 x 3= 585, etc.

Floor price: It is the lowest price at which one can bid for an IPO. In the case of the book-building method when a price band is set, the lower limit of the price band is the floor price. For instance: The price band for the Zomato IPO was fixed at 72-76 per share. This means that 72 was the floor price for this particular IPO.

Cut off price: It is the price at which shares are allotted to retail investors in an IPO. It is decided on the basis of how much price most investors are willing to pay for a share. If one bids above the cut-off price he/she will be allotted the shares and the extra amount will be refunded. If he/she bids below the cutoff price, shares will not be allotted to him/her.

Underwriter: An underwriter is an intermediary, generally an investment bank that provides the guarantee of selling a minimum number of shares to the company releasing an IPO. An underwriter plays various roles such as marketing the IPO, allotting shares, etc. In case the underwriter fails to sell the guaranteed number of shares, it is liable to buy the said shares itself.

IPO investment can seem to be a daunting process as the terminologies tend to drown one in their complexities. Once you are armed with the knowledge of the details and salient features of an IPO, the road ahead can be quite smooth. Some of these key terms have been explained in more detail below.

What is a Draft Red Herring Prospectus (DRHP)?

A Draft Red Herring Prospectus (DRHP) is a registration document filed with SEBI by a company that wishes to release its IPO. Also known as the offer document, it contains information about the company’s business, finances, why it wants to raise capital, how it will utilise the money, risks involved for the investors, etc.

DRHP is essentially a preliminary document prepared by underwriters for the book-building issue and may not contain the price per share. However, it contains a price and is available to the general public who can submit their comments to SEBI.

How is a DRHP prepared?

After a company gets initial approval from SEBI on the registration statement, it needs to prepare a DRHP. The underwriters draft the prospectus and ensure complete due diligence and legal compliance. The draft prospectus must be submitted at least 21 days before the launch of the IPO. During this period SEBI reviews the document and suggests changes to the company.

After the company makes these revisions the DRHP extends and officially becomes the ‘Red Herring Prospectus’ which is the final prospectus of the IPO and contains the IPO dates, price, and is updated with the latest information.

What is the need for a DRHP?

It is a mandatory requirement of SEBI that all companies reaching the Registrar of Companies (RoC) to release an IPO have a DRHP. Not only is it a requirement for the company, but a DRHP is also referred to by the investors and it supports them in making an investment decision. It protects the rights of the investors by providing them all the necessary details.

Where can a company’s DRHP be found?

A company’s DRHP can be found on the underwriter website, the company’s website, the official websites of the stock exchange (s), and SEBI. In the case of famous IPOs, it may also be found on various other news and media platforms.

An IPO is a complex process for both the company and the investors. It must be noted that a DRHP is not the final prospectus offering securities but a document that aids both parties by furnishing all the details that are necessary for SEBI compliance (for the company) and understanding the risks involved in the investment (for a potential investor).

What is a Deemed Prospectus?

A prospectus is a document issued by a public company in compliance with SEBI regulations to offer its securities for trading to the general public. This article covers the meaning of a deemed prospectus and explains its purpose through the medium of an illustration.

Meaning

Whenever a company allots or agrees to allocate any number of its shares to a financial intermediary like an investment bank, that buys the securities for eventually selling them further, a deemed prospectus is made. The prospectus reflects an “offer for sale” to the public extended by the intermediary.

A deemed prospectus should satisfy one of the following conditions:

Offer for Sale to the public was made within six months after the shares were allotted/agreed to be allotted to the intermediary.

The company did not receive the whole consideration w.r.t. the securities till the date when the offer was made. This means that only after the offer of sale of securities has been made to the public by the intermediary, the issuing company receives any consideration regarding the same.

What is the purpose of a deemed prospectus?

The purpose of the deemed prospectus is to ensure accountability of the original issuer of the security. Even when a company allots its shares through an intermediary to escape complying with SEBI ordinances, all the liabilities that apply to the prospectus of the company are also applicable to the deemed prospectus. 


Thus, the deemed prospectus clarifies that even though the intermediary sold the stocks to investors, the offer of sale will be considered to be a prospectus dispensed by the company.

A hypothetical illustration

Suppose company A wants to issue its shares to the public without having to go through the process of compliance with Section 26 of The Company’s Act or SEBI guidelines. Company A will then allot its shares to an intermediary, say in this case, an investment bank JPMorgan & Chase Co.

Now A allots its shares indirectly through JPMorgan as it can allocate the shares to the general public through the offer of sale. In this case, JPMorgan is company A’s representative, and the offer of sale issued to the public by JPMorgan is the deemed prospectus of company A if one of the above-mentioned conditions is fulfilled.

A deemed prospectus is an important document to pinpoint accountability to the issuing company. Before investing in any security individuals are advised to calculate the risks associated with the investment by going through all the documents issued by the involved repositories.

What is an Abridged Prospectus?

An abridged prospectus is a mandatory memorandum that supplements an IPO. It provides a brief summary of all the significant details and salient features of the IPO as specified by SEBI. It is meant to promote the interests of the investors as it provides a crisp outline of the vital factors of an IPO that might otherwise be missed while reading the original prospectus that is lengthy in nature.

In simpler terms, an abridged prospectus is a brief document that contains all the details that provide necessary details related to an IPO. It summarises the prospectus of the IPO and aims to provide a detailed understanding of the finances, details of the underwriter, and other information of the IPO & the company in a compact manner using fewer words.

What are the features of an Abridged Prospectus?

  • Format: In 2012, SEBI prescribed a specific format to be followed while drafting an abridged prospectus. This action was meant to promote uniformity as different application forms and abridged prospectus were being used in public issues of debt securities previously.
  • The format standardised the structure, design, format, contents, and organisation of information in these documents. Some of the indicated points include ‘Times New Roman’ font, font size of not less than 10, line spacing not less than 1.00 lines, etc. The format of an abridged prospectus cannot be changed.
  • Constituents: An abridged prospectus essentially contains the following information- details relating to the issuing entity, disclaimer, details of issue procedure, terms of issue, legal information, risk factors, declarations, and details of centres where application forms are available.
  • Mandatory: Section 33 of Companies Act. 2013 mandated all the application forms for the trading of shares to be accompanied by an abridged prospectus. Failure to comply with this provision would draw a fine of 50,000 for each such default.
  • Exceptions: Only under the following anomalies an abridged prospectus may not be attached to an application form:

If the shares/debentures are not proposed to the common public.

In case bonafide invitation to enter into an underwriting agreement is received

An abridged prospectus is a convenient tool for investors that safeguards their interest and protects them from risks associated with lack of information. Not only does it save their time but also secures their rights by informing them about the consequences, and outcomes of investing.

What are some common myths about investing in an IPO?

There are a lot of myths when it comes to Initial Public Offerings, like IPOs, in general, a very sceptical topic for investors because of a lot of reasons to name a few will be lack of understanding for a layman, high uncertainty, good amount of research time for making an informed decision, etc.

Below are some myths related to IPOs :

Myth 1 - Company going public which makes it financially stable

It is often assumed that the company that is going public must be financially stable but the statement is not true. A company decides to go public because it wants funds for carrying out activities.

Though it can be said that the company that is offering IPO would use the funds raised for expansion, growth, mergers, and acquisitions which can lead to financial growth on a much larger scale than before which would definitely be gainful for investors. But if the fund is being raised for paying only the debts then the company is definitely not financially stable nor will it provide many gains to the investors.

Myth 2 - Individual Investors are awarded IPOs

The above statement is very rarely true. The reality is that institutional investors are the primary investors, they are the ones who purchase multiple stocks at once. Usually, people who underwrite the company who has decided to go public want to give primary chance to institutional investors as the underwriters want the investors to hold the shares rather than sell them in the open market, with price volatility.

Therefore, when a big multinational decides to go public there are not enough shares for both institutional or individual investors, because of which individual investors may have to wait in the secondary market, where securities are sold after IPOs.

Myth 3 - Investment in IPO gets me on the ground floor

The above statement is partially true. The company before going public, tries out private investment. Therefore, investors investing in IPOs are not the ones with the access in the very first place, on the other hand they are called first public owners.

There is always a difference between IPO offering price and price of what individual investors will pay in the stock market. The price of public offering is decided much ahead in time for institutional investors, owners and some investors who come under certain eligibility criteria.

Myth 4 - All IPOs are high risk, high reward

The above statement is not true under all circumstances. The key to find whether a particular IPO for a certain company is profitable or not is only research and scepticism.

It is not always necessary that hype companies give high rewards on IPOs, sometimes companies who do not have a much bigger name do pretty well as their business model and other factors are at the stronger levels and have a scope for improvement.

Myth 5 - IPOs outperform their peers

It is said that IPOs offer something new, fresh to investors which shows great potential and is believed to give a good return to the public, while the fact says otherwise. It is researched and backed by the statistics that IPOs have narrowed their performance over the years than their peers like equity shares or mutual funds etc.

Rushing in the decision of buying IPOs should not be followed. Reassuring every step is a must, sometimes it does happen that the company which was hyped a lot before going public does not do well and the investors do not gain the reward they anticipated.

With the increase in technology and information, a lot of pros and cons have been listed for new investors which can be looked over before investing and thus making the myths vanish and resulting in a rational decision.

What are a few things to watch out for before buying an IPO?

The stock markets have various options of investment. Some of the few examples are equity shares, mutual funds, debentures etc,. The main question stands in action: which one to invest in?

All these shares and debentures have their own risk factors and gains which are constant to their nature. The final decision factor which comes into play is the investor’s risk appetite and amount of investment he/she is ready to make.

Initial Public Offering has been a popular choice of investment in the stock market, following are the pointers which an investor should keep in mind before investing in an IPO.

Profile and Objective

Whenever a big company goes public, there is usually a lot of hype in the market which sometimes leads the investors to invest in them without proper research and understanding. It is important for investors to know its clear objective before buying an IPO of any company. A lot of times people get influence in buying IPOs because of peer recommendation, or simply because the company is a recognized one. But the reasons should definitely go deeper than this.

Potential in the Market

IPOs allow companies to raise a good amount of funds that can be used by the companies for further expansion, growth, mergers, etc. It is important to look out for such information regarding the company before investing in it. Analysing the true potential of the company among its competitors and market will give a better understanding and a well-informed decision will lead to higher returns in the future.

Utilisation

Utilisation of the proceeds gained by going public tells a lot about the company. The investors before making their investing decision should read about how the company is going to utilise the proceeds. If the company is only going to pay its debts then investing in such a company would not be fruitful, but if the company says that it will expand, will conduct mergers then the investment is attractive and worthy.

Valuation

The process of valuation can be a little challenging for retail investors but have been considered as a beneficial step in making the investment decision. To evaluate one company’s shares with another, the analysing tools which can be used are Price-to-Earnings ratio or Price-to-book ratio etc. The investor can also compare the performance of the IPOs of the companies present in the market to gather a better understanding.

Understand the Backing

Investors a lot of times make their decisions after looking at the strong nroekerages and big underwriters. However, these factors do not guarantee good returns on your investment. Factors like past performance, future goals, management stability and growth prospects should be the main reasons for investors to show interest in buying IPOs from the company.

To conclude, the decision should be based on the investor’s risk appetite, personal objective and whether the investor believes in the company’s goals. The decision should not focus on the hype in the market, peer recommendation or simply for the fear of missing out on an opportunity. Scepticism always plays an important role while investing and should be followed by all investors along with a thorough understanding of the market and research about the company.

How to Analyse an IPO?

A company’s prospectus gives out a lot of information about the company. The investors should feel confident about the growth prospects of the company when they are investing in, and should know what the company plans to do with the proceeds earned by going public.

To analyse the IPO of a particular company, it is advised to look out for the size of fresh issue and the size of the offer for sale. Initial Public Offerings consist of both Fresh Issues and Offer for sale (OFS). Fresh issue refers to the capital used to run the business while OFS refers to the stocks given up by the promoters etc.

If OFS is greater than a fresh issue then it means that the promoters themselves are not confident enough in the business and want to get rid of the ownership which clearly represents a red flag for investors thinking to invest in a company with this particular situation.

Fresh Issue

When analysing fresh issues, it should be kept in mind that why the company is raising the capital for. If the prospectus says that the company wishes to expand its product range, growth or, would be going forward with amalgamations or acquisitions then the investors should give attention to the company as there is a lot of room for development which will result in good returns in the upcoming future. But, if the company wishes to only pay its debts by the proceeds earned then the investor should reconsider their opinion of investing in the particular company.

Offer for Sale

If the offer for sale has been made by the promoter of the company, then the investor should know the reason behind such a move. If the promoters have given out more shares than expected, then maybe they have lost confidence in the working of the company. This factor needs to be researched upon by the investors before choosing the company they want to invest in.

Trading in IPOs can be a little intimidating but thorough research can solve the problem to a great extent. Familiarising yourself with a company's goals and future plans can make the investor understand the condition of the company a little better and make the decision-making more accurate.

How to apply for an IPO under a minor’s name?

Minor is a person who is below the age of ‘18’. The number 18 for claiming a person as an adult can vary from country to country, but most of the countries including India considers an individual as an adult who is 18 or above. A minor can apply for an IPO under the guidance of a guardian.

Let us look at various aspects, under how a minor can hold an IPO.

How to apply for an IPO for a minor?

Firstly, to begin a demat account should be opened under the name of the minor with a permanent Pan Card number. Pan Card is usually that of parents as minors are not eligible for pan card also because they don’t have a fixed income of their own. Even though a demat account can be opened for a minor, a trading account can’t.

Trading account of a parent or guardian must be linked with the demat account of the minor. Then the account thus made should be linked with the bank account used by the minor, and further KYC forms of the minor and the parents need to be submitted. Then the account will be functional and the investor can invest in the IPO.

Third party facilities like Blocked accounts (ASBA) are considered ideal for making payments. But it is important to note that when considering ASBA banks don’t allow this facility to minors, therefore parents can access the option by using their own accounts.

It can be noted that minors aren’t eligible for tax deductions and any grants are subjected to be taxed. Once the minor reaches the age of an adult he/she can close the minor account and start with a new account or can convert the account into a major one and can start with the investing process again.

Importance of investing from a minor’s name

Several consider investing from a minor’s name beneficial because of various reasons. First being that the minor understands the meaning of saving funds from an early age and how important it is to invest with regularity. Investing from a minor’s name is also tax efficient. Also, the gains earned from the minor’s account are not clubbed with parent’s which result in keeping them aside and not use the reward until the minor enters adulthood after which it can be used for his/her own good and future.

Tax Implication on Minors

As fruitful as it may sound, financial advisors suggest not to apply for IPOs under a minor’s name because for this the parents or guardians have to indulge in bank formalities for making a bank account, demat account etc and plus there is no special tax rates for minors. The short-term (assets held for less than a year) are taxed at 10% while the long-term gains are tax-free. The minor will be eligible for exemptions and deductions extended to any other taxpayers.

What happens when the minor turns 18?

When the minor turns 18, they can decide to convert their minor Demat account to a major one by replacing the details of their parents/guardian with their own or they can close the functioning minor account and make a new one.

Because, when the individual was a minor they had to use a demat account which was under their name but had details of their parents/guardians, trading account linked to their demat account was not theirs as they weren’t eligible for the same and pan card was also of the parents/guardians. Once they turn 18, they are eligible for all such accounts and cards, and thus can either change the details or can close the existing ones and start anew.

Bottom Line

Investing in IPOs is always considered beneficial as the companies who decide to go public have a lot of scope for growth and double the reward of the investor. Like equity investments, IPOs are also considered to provide rewards for a long-term which can be useful for investors who are looking to spend the funds in an expensive leisure.

First Published: 17 Jan 2022, 12:06 PM IST
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