Q1. I'm a 25-year-old fresher working as a doctor at a private hospital in Gurgaon. I have always been interested in investing in IPOs, however, as a novice, I am unaware about the process and the documentation required for investing in an IPO. Can you please provide a brief outline of the IPO process and key terms used in an IPO such as book building?
Mansukh Kharge Gurgaon, Haryana
IPO or Initial Public Offer is the process through which a company gets listed on the stock exchange and raises funds. As demonstrated from the name IPO is an event through which a company’s stock is available for purchase to the public at large for the first time. Most companies before becoming a public listed company are a private company. Private companies attract less regulation and less regulatory oversight when compared to their publicly listed counterparts.
Listed companies are not only regulated by the Ministry of Corporate Affairs (like private companies) but are also regulated by the Securities and Exchange Board of India (SEBI). Listed companies acquiesce to higher regulatory oversight in exchange for access to public funds.
READ MORE: What is FPO and how is it different from IPO? MintGenie explains
Below is the list of key terms one should know in relation to an IPO:
Red herring prospectus
It is the final prospectus that the to-be-listed company submits to the Registrar of Companies (ROC) and to the Securities and Exchange Board of India prior to the IPO's launch. The company's business description, management qualifications, operational facts, future plan, IPO price range, the intended use of the funds, and the IPO calendar are all included. It also covers all the information investors require about the company and the IPO. It is also known as the offer document.
Prior to investing in an IPO, it is highly recommended that a prospective investor goes through the offer document in detail and understands the future business plans of the company and review the past performance of the company too.
The price range for the to-be-listed shares of the company is called ‘price band’. It is important to note that there is no guarantee that upon getting listed the price of the shares of the company will not go below the price band specified in the red herring prospectus. Upon listing, market forces determine the price of the shares.
READ MORE: Direct Listing: How is it different from an IPO?
Book building process
The book-building process is the process through which the price of the to be listed shares is determined. It is important to understand that the price which will be discovered through the book-building process will be within the price band. Major factor in the determination of the price of the shares is the number of bids received for them to be listed shares at various price points within the price band. Historically for most IPOs the price which is determined at the end of the book building process is the upper end of the price band.
The listing date is the date when the shares of the company are officially admitted for trading on the stock exchange and become available to the public for trading. Prior to the listing date shares of the successful bidder are allotted to them and are transferred to their demat account.
Retail individual investors
NRIs, Hindu Undivided Families, and individual Indian residents fall under this category of Retail Individual Investors. Under SEBI regulation it is mandatory to reserve 35% of the shares being offered through an IPO for Retail Individual Investors. Retail Individual Investors cannot invest more than ₹2 lakh in an IPO.
READ MORE: What is the role of an IPO in the Stock Market?
Over and under subscription
A to-be-listed company never receives exactly the same amount of applications as the number of shares it is offering through the IPO. Oversubscription is the term used when there are more applications received than shares that are available for allotment. In contrast, an IPO is said to be under-subscribed if the total number of applications are less than the total number of shares available for allotment.
Application supported by blocked amount (ASBA)
Historically investors interested in IPO were required to deposit the investment amount with the to-be-listed company upfront. In case their bid was unsuccessful their money would be reimbursed, however, that was a long-drawn process. Under the current SEBI regulation no amount is deducted from the bank account of the investor, the requisite amount is only blocked but it remains with the investor only. The requisite amount is transferred from the bank account of the investor to the bank account of the to-be-listed-company only at the time of allotment of the shares of the to-be-listed-company.
Now that we are clear with the key terminologies pertaining to IPO let us now understand the the key steps involved with an IPO
Step 1 - Hiring of advisors
For the purposes of managing the IPO process, the to-be-listed company will employ a number of advisors. The company will enlist the aid of financial professionals, such as investment banks, legal advisors, underwriters, etc. The specialists will also review the company's critical financial metrics and provide inputs to the company.
READ MORE: The 5 biggest myths about investing in IPO
Step - 2 Filing of draft red herring prospectus
The to-be-listed company will file the draft red herring prospectus with SEBI, the DRHP will be available on SEBI’s website for access to the public. SEBI will provide its comments on the DRHP. If satisfied SEBI will grant in-principal approval for listing.
Step - 3 Filing of red herring prospectus
As discussed above Red Herring Prospectus contains all details in relation to the company, risk factors, and intended use of funds being raised through the IPO. To-be-listed company will file the Red Herring Prospectus with SEBI. RHP will be available on the website of SEBI as well as on the website of stock exchanges where the company proposes to be listed.
Step - 4 Opening of subscription period
IPOs are typically open for a period of 3-4 days, during which bids are received for the shares.
Step - 5 Price determination and share allotment
Once the subscription period is over, the share price is determined on the basis of the book-building process. Once the share price is determined the successful bidders are allotted shares.
Step - 6 Listing
The last step of the IPO process is listing of the shares on the stock exchange after which they are available to the general public for trading.
Investing in an IPO is a simple process nowadays due to technological developments. However, all investments in the stock market are subject to market risk and it is advisable that new investors undertake thorough research on a company prior to making any investment decisions.
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Note: This story is for informational purposes. Please speak to a financial advisor for detailed solutions to your questions.