All you need to know about investing in an IPO


Here is a guide to understanding what an initial public offering (IPO) is and how to invest in one

We often hear of companies launching their initial public offering. In this article we examine what an IPO is and the nitty-gritty of how to invest in one.

 

What is an IPO?

Money earns money. So, goes an age-old adage. This is particularly true for the growth of companies. For their growth, companies constantly need liquidity. An IPO is a route for raising funds from the market.

Borrowing from the market (the general public to be more specific) often becomes an obvious choice for a growing company that has already used up a lot of private capital for its expansion. To borrow money from the public, a company must list itself in the stock market. Launching the initial public offering or the IPO, is the way to list a company on the stock exchanges. This process provides companies the legal sanction to borrow capital from the public.

An IPO is the initial sale of a company’s shares to the public, institutional investors and high-net-worth individuals. Once a company issues its public offering and gets listed on stock exchanges, it becomes a public company. Prior to this it remains a private company. This means that while the shares of the company were held privately earlier, they are held by the public after the launch of the IPO. In other words, initial public offerings are the process by which a private company becomes public by sale of its stocks to the general public.

According to the Securities and Exchange Board of India (SEBI): “When an unlisted company makes either a fresh issue of shares or convertible securities or offers its existing shares or convertible securities for sale or both, for the first time to the public, it is called an IPO. This paves the way for listing and trading of the issuer’s shares or convertible securities on the stock exchanges.”

Any company (a startup or an old private company) can file for an IPO and become a public company. In this process, the company either issues new shares to the general public or the company’s stakeholders sell their existing shares in the company to the general public without raising any new capital.

After the launch of the IPO, a company’s shares are traded in an open market.

 

What is IPO

 

What is the need for Initial Public Offering?

Once a private company becomes profitable and plans to expand, it needs more capital to fund its plans. At this juncture, going public becomes the natural choice to raise equity capital.

Companies file for IPO broadly for the below-mentioned reasons:

  1. Being publicly listed, they are able to raise funds from a wider pool of investors, i.e., the general public.
  2. The IPO launch enables and facilitates mergers and acquisitions.
  3. The IPO launch helps them gain visibility.
  4. An IPO is also an opportunity for early investors of the company to make an exit.

 

Eligibility to launch an IPO in India

A company must have a minimum paid-up capital of Rs 10 crores, to get listed on the National Stock Exchange (NSE) or the Bombay Stock Exchange (BSE), the two major stock exchanges in India. The company’s post-issue market capitalisation should also not be less than Rs 25 crores.

See also: Real estate versus stocks of realty companies: Which has better returns?

 

Disadvantages of IPO launch

Becoming a public company is no easy feat for a company. Apart from the fact that it would have to do extensive paperwork and comply with a multitude of market security norms, the company will also have to make substantial spending in launching the public offer.

Compliance and cost are two of the biggest responsibilities that a company planning to file for an IPO has to shoulder, something that discourages some companies. Also, a public company has a much greater exposure and faces regulatory scrutiny at all times.

 

Alternatives to an IPO

If a company is not willing to go public, it has other options to raise capital, via private equity, venture capitalists, or angel investors.

 

IPO related terms

Price band

This refers to the price range within which investors can bid for the company stock for the first time. The spread between the floor of the price band and its cap, should not be more than 20% according to SEBI regulations.

Draft Red Herring Prospectus (DRHP)

The Draft Red Herring Prospectus or the offer document, contains all the information about the company, its promoters, projects, financial details, terms of the issue, objects of raising the money, etc. The IPO DRHP is used to invite subscription to the issue being made by the issuer. It contains all the relevant details except for the price and the number of shares being offered.

Merchant banker

The merchant banker performs the due diligence to prepare the offer document (or DRHP), which contains all the details about the company. The merchant banker for the IPO is also responsible for ensuring legal compliance in the entire issue process and for marketing of the issue.

Bankers to the issue

Bankers to the issue enable the movement of funds in the issue process and therefore, enable the registrars to finalise the basis of allotment by making clear the status of funds available to the registrars.

Registrars to the issue

They are involved in finalising the basis of allotment in an issue and for sending refunds, allotment details, etc.

Underwriters

These are intermediaries, who undertake to subscribe to the securities offered by the company, if it is not fully subscribed by the public.

Under subscription

An IPO is undersubscribed if the bids received are less than the number of shares offered.

Oversubscription

An IPO is oversubscribed if the bids received are more than the number of shares on offer.

Green-shoe option

This green-shoe option enables the issuer company to release additional shares in the event of oversubscription. Provisions about this are mentioned in the underwriting agreement.

See also: What is a REIT (Real Estate Investment Trust) and how to invest in one

 

How to invest in an IPO?

Must-have documents to invest in an IPO:

  1. Demat account.
  2. Trading account.
  3. Mobile number linked to the bank account.
  4. UPI ID (a banking system for money transfers on payment apps).

 

Step-wise process to invest in an IPO

Step 1: Log into the trading app or mobile application of the broker.

Step 2: Go to the ongoing IPO section.

Step 3: Select investor type and the IPO.

Step 4: Enter the number of shares and bid price.

Step 5: Also enter the UPI ID.

Step 6: Once the application is submitted, the request is sent on the UPI application for approval.

Step 7: Log into the UPI application and accept the mandate request. Once it is accepted, the amount for the IPO is blocked.

Note: The whole amount will be debited if the applicant is allotted all the shares he has applied for. If only some shares have been allocated to the bidder, only a part of the money will be debited and the remaining amount will be unblocked. The entire amount will be unblocked if no shares have been allotted.

 

Can I change or revise my IPO bid?

Yes, you can change or revise the price or quantity in the bid, using the form for changing/revising the bid that is available with the application form. However, the revision/change in bids should be completed within the date of closure of the issue.

 

Can I cancel my IPO bid?

Yes, you can cancel your bid any time before the finalisation of the basis of allotment, by approaching/ writing/ making an application to the registrar to the issue.

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Tips to invest in IPO

While IPOs provide investors with great options to multiply their money, a great deal of care and diligence has to be applied, to make the most of this financial tool.

Since there is no historical data available in the public domain about a company that has set out to launch an IPO, it might be hard to gauge the financial health and stability of the company. This could impact your chances of profit-making in an IPO investment.

The red-herring prospectus of the company released at the time of the IPO launch, is your only way to have an understanding about the company and its financials. Make sure you study the IPO DRHP carefully. Also track all news about the company and its past performance.

Your profit-generating potential is directly related to the company’s performance. Hence, it is essential to ensure that the company’s prospects are promising.

 

FAQs

Is it compulsory to have a Demat Account to invest in an IPO?

Yes, you are required to have a Demat account to invest in an IPO.

Is it compulsory to have PAN to invest in an IPO?

Yes, it is compulsory to have a PAN to invest in an IPO.

Who fixes the price of securities in an issue?

The company issuing the IPO, in consultation with the merchant banker, decide the share price, on the basis of market.

How many days before the opening of an IPO should the company reveal the price band?

Companies launching an IPO are required to disclose information about the price band at least five working days prior to the opening of the issue.

 

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