Initial Public Offering (IPO) enables the transformation of a privately-held company into a public company. It gives rise to an opportunity for smart investors to earn an attractive return on their investments. It is initiated to infuse new equity capital into the firm.
Additionally, a firm might also open an IPO to monetize the investment that is made by the existing stakeholders, raise capital for its future prospects or to ensure smooth trading of the already existing assets.
Types of IPOs
IPOs can be broadly categorised into two types:
Fixed Price Offering
The price under this IPO is evaluated by the company with the consultation of their 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.