Distinctive trait of a Bull market is issuance of IPOs by several companies. When markets are upbeat companies line up with their initial public offerings. Here’s everything that an investor needs to know about an IPO.  

So, what is an IPO?

When shares of a particular company are offered to the public at large for very first time it is called Initial Public Offering. It is the very first time when shares of a particular company are getting listed on the stock exchanges.

IPO market is called as “Primary Market” and market where buying & selling in these shares happen after they get listed is called “Secondary Market.”

   Firstly, why does a company come out with an IPO?

  • To raise money from investors.
  • They use this money usually to fund their future expansion or sometimes to pay off their old borrowings.
  • Apart from this, getting listed brings a lot of prestige to the company because not  all  companies are capable  of coming out  with an  IPO and  getting  listed  on the stock exchange.
  • In addition to this, it helps existing shareholders to identify true value of their shares that they are holding. Because now true value of the shares will be decided by millions of investors who will be trading in this stock once it gets listed.

Why do investors invest in IPO?

Investors who invest in an IPO believe that the price at which they are offered the shares now in the IPO  is much less than the price  that will  prevail  once the  shares get listed  on the  Stock Exchange i.e  they are looking for an opportunity to make listing gains.

The IPO process & the “Red Herring Prospectus”.

  1. On deciding to come out with an IPO, the issuing company first appoints “Book Running Lead Managers.” They help the company – in getting approval from SEBI, promoting and Marketing the  IPO and finally getting shares listed.

Once book running lead managers are appointed, they along with the company file the draft offer document with SEBI for its approval

Draft offer document basically contains information about the company, about the promoters, the shareholders, the business of the company, the financials of the company, information about the risk involved in investing in the IPO etc. So, it has all the information that an investor is looking for before deciding whether to invest in the IPO.

If SEBI is satisfied with the draft offer document then it will give its approval, otherwise it will ask the issuer company to revise its draft offer document and company will have to revise and reapply for approval with SEBI. Once draft offer document gets approval of SEBI, it is then called as “Offer Document” . Offer document is then sent to registrars and stock exchanges.

Registrars are the agencies that do the back office work for the IPO, like collecting the forms, collecting the bids from the investors, allocating the shares etc.

Once the Offer document gets cleared by the exchange, the company adds “Issue size & Price per share” in the offer document. The offer document now becomes a “ Red herring prospectus” and is available to the public which they can go through before investing. As mentioned earlier it contains all the information that an investor looks for to decide whether to invest in the IPO.

The main difference between the offer document and the red herring prospectus is that the red herring prospectus consists of the issue size and the price of the IPO which is absent in case of offer document.

Issue size is basically the amount of money that company is planning to raise from the market through the IPO.

Based on the pricing there are 2 types of IPO:

  1. Fixed price IPO: Where the offer price is “fixed”, and known to the investor before applying.
  1. Book Built Issue: Here a fixed price is not given rather instead of giving you a fixed price they give you a price range. The logic being that these shares have never been traded earlier so the company does not know the exact price at which investors will be willing to buy the shares. The investors then have to place their bids within this price range and based on the bids received final offer price is determined.

It is important to note that retail investors (i.e investors applying for less than Rs 2,00,000) have an option to apply at “Cut Off Price”. If they select “Cut Off” option price in their application form, it means that whatever is the final price arrived by book built option, they are willing to buy the shares at that price.

Out of the total shares on offer in book built issue, around 50% is reserved for QIBs (Qualified Institutional Bidders) like Banks, Foreign Institutional Investors, Mutual Funds etc who are registered with SEBI and who apply in large quantities.

Within the QIB category there are some investors called the “anchor Investors” . These are qualified institutional investors who apply for shares of value of Rs 10Cr or more and who are allowed to invest in the IPO before the IPO hits the market.

Why are anchor investors allowed to invest in the IPO before it hits the market? – because they build confidence to retail investors who are planning to invest in the IPO. Because when investors see that anchor investors have invested heavily in the IPO it gives them confidence to apply in the IPO.

Apart from this around 35% is reserved for retail investors i.e investors who apply for Rs 2,00,000 or less and balance 15% is reserved for other non-institutional bidders which includes NRIs, companies, trusts, High Net Worth individuals etc. who apply for more than Rs 2,00,000 of shares.

Meaning & Implication of IPO getting oversubscribed:

Oversubscription means that the demand for shares in the IPO is much more than the number of shares that are on offer.

This implies that now the company cannot issue to you all the shares that you have applied. In fact there are chances that you might not get a single share if the issue is oversubscribed heavily because company allots shares based on lottery system in case of oversubscription.

To ensure you get at least some shares it is important to understand that as only 15% is reserved for individuals in non-retail category where as 35% is reserved in retail category, there are chances of higher allocation of shares in retail category if the issue is heavily oversubscribed. So, it makes sense that you apply in retail category if the issue is very popular and chances of oversubscription are very high

Also if the issue is very popular and is expected to be heavily oversubscribed, its best to apply for the minimum lot because even if you apply for more lots then there is little chance that you will get more than 1 lot and your money will be blocked unnecessarily

Also it helps to apply in IPO through ASBA as application money shall be debited from the bank account only if your application is selected for allotment after the basis of allotment is finalized

So what is ASBA?

ASBA means “Application Supported by Blocked Amount”

Here the amount for which you have made the application gets blocked in your account first but only that amount of money gets deducted from your account that corresponds to the shares that are allotted to you.  So the advantage is that you continue to receive interest on your application money till the time it is blocked and you don’t have to bother about the refunds if shares are not allotted to you or only few shares out of the total applied are allotted to you.

Few timelines:

  • A Book built issue, is usually open for subscription for 3 – 7 working days
  • It takes around 6 to 7 working days post subscription for the stock to get listed on the exchange.
  • SEBI however is trying to reduce this time further so that the investors are not exposed to market volatility because when you apply for the IPO the market scenario may be good but the time it gets listed, suddenly there may some news which may affect the overall market and thereby affect the listing price of these stock. Therefore, to reduce the exposure to market volatility the time form when you subscribe to the time shares get listed, must be reduced as much as possible.

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