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In this detailed analysis, we’ll be discussing the IPO, which stands for Initial Public Offerings. It is a process by which a privately held company turns out becoming a public company by offering its equity to the public for the very first time.
Below is the list of topics which are being covered in this analysis.
Stock Market is an exclusive and non-predictive way of investment. Although, there are many ways you can invest in the Stock Market. You can invest through the Mutual funds, or through the IPOs or even directly in the companies on your own. One should be well-versed with the concepts and workings of the stock market in order to invest in it. But the question that many people might have in mind is that why should we invest? Investment is necessary for your personal growth as well as for the economy. Let your money work for you, and this happens when you invest. Investing through an IPO might be considered as a task itself, but it isn’t.
Let us understand the IPO in detail.
When a company for the first time plans to offer their share publicly in order to raise money from the public is called an IPO or Initial Public Offering. It is also a process where a Private company finally becomes a public company, with the sale of its share to the general public. And this whole process is handled by the SEBI (Securities Exchange Board of India). SEBI is a capital market regulator. Just like the Reserve Bank of India (RBI) is the regulator for Banks, the same way SEBI regulates the capital market.
Companies get themselves listed to the Stock exchange so that people can easily buy their shares. Also, a common term, ‘going public’ is also used when a company launches a
You must be thinking that why does a company needs to raise money, and if they do, then why ask from the public? What does going public means?
Well, let us understand this. So before the IPO, a company is only a private entity, which states that the investment is limited with few investors, like the venture capitalists, angel investor, or sometimes even friends or family. And through them, they get investment for their company but not at a large sum. But now, since the company is growing efficiently with its products and services, it now wishes to expand more. But for expansion, it requires a huge amount of money. How will it get it? Who will give them such a great amount of money?
This is where IPO steps in. In order to raise a huge sum of money, IPO is the best decision a company could make, although it is a very big step for a company. But this big step gives them the ability to expand and grow to its fullest. As when the company becomes public not only a few investors become a part of it, but thousands of investors become a part of it.
This way a company raises money and in return, they give ownership to the investors who are buying the shares of the company. There is a kind of transparency of share listings among the company and the investors, which somehow binds them together. The number of shares which the company sells enhance in generating new shareholders of the company.
For a company to go public is a huge decision itself. There could be ample reasons for this, but let’s discuss the most basic ones.
Growth and Expansion-
When a company is a private firm, is reaching its heights, then those companies have plans to expand their business even more. For instance, ABC company has shown enormous growth in Mumbai with its top-class products ad services, but now apart from Mumbaikers, they wish to serve more people. And for this, they wish to add up more new products and services and branches. Well, all of these required a large sum of money.
Before even considering the option of IPO, they might go directly to the banks for a loan, but over there the problem is that, firstly, banks generally don’t give such huge sum of the loan and secondly if they do then the company has to pay back the amount along with interest on that amount.
Now, this is where IPO again comes to the rescue. How? Let us understand.
When a company plans to generate money through the process of IPO, then they don’t have to pay back the amount which they have raised from the public. Instead, they give ownership to the investors in their company. This way they won’t have to pay the amount nor any interest.
Mutually both the company and the people buying IPO benefits from this. Company get benefitted with the money they needed, and investors get the ownership in those companies.
Launch of New Products and Services:
This point is somewhat related to the concept of growth and expansion. But many times, a company doesn’t wish to open new branches and instead, they just wish to add more products or services for the people. Launching a new product or a service requires a good sum of money, and thus, IPO is the best option. When a company launches a new product or a service, promotion is the key source for new products to level up.
And thus, with this aim, they launch an IPO, one to raise money and second to do an indirect promotion.
Reduce Debt burdens and Loans:
Big companies are many times a victim of a huge amount of debt. In order to reduce their debt burden, they again take some money from the bank to give away the previous debt, but through this way, they are clearing the old debts but they are also adding up new debts. In short, this is not the best way to reduce the burden of debts or loans. The best option would be to get a good some amount of somewhere and thus, clear off all the debts.
Now the question is How is this even possible, especially for big companies? This is also one of the reasons good companies go through the process of IPO. Just by selling some of their shares they raise money from the public and this way, they are able to reduce the burden of their debt and thus, they continue to outshine once again in the market.
There are two types of IPO, one is the Fixed Price IPO and second is the Book Building IPO.
|FIXED PRICE||BOOK BUILDING|
|In this type of IPO, the company decides a fixed price of the shares, and on that same price, people have to buy the shares.||In this type of IPO, the company decides a specific price band.|
|For instance, if an ABC company has set a fixed price of 500rs per share, then people who are willing to subscribe to it, will have to buy the share at Rs. 500 only.
Also, in this type, generally, the price is mostly lower than that of the market value.
|For instance, if an ABC company plans to bring its IPO through book building, and has set the Price band of shares between 300-306.
Then people who are willing to subscribe it will have to buy within the price band of 300-306 and have started their bidding.
Whichever will be the highest bidding price, on that price the further shares will be bought.
If the price of an IPO is less then it is called the Floor price
If the price of an IPO is more then it is called the Cap Price.
As we have discussed what an IPO is, here we will be discussing about the process for applying for an IPO with the perspective of both the company and Investor.
IPO PROCESS FROM THE PERSPECTIVE OF THE COMPANY-
This whole process is distributed in a few steps-
First is when the company, finally after all the decisions plans to raise money from the public. Though this is a tough decision.
After the company has agreed on launching an IPO, the next step they do is to contact a number of investment banks. The whole process of an IPO is controlled by the SEBI (Securities Exchange Board of India).
SEBI is a capital market regulator. Just like the Reserve Bank of India (RBI) is the regulator for Banks, the same way SEBI regulates the capital market.
Then these Investment Banks will guide the company related to the IPO and with that, they also make their DRHP (Draft Red Herring Prospectus).
DRHP consists of the company’s history, financial statements history, details of the company’s promoters and management, the company’s future plans and almost everything related to General Consultancy.
Then this DRHP is forwarded to SEBI. SEBI checks and analyses it, and if SEBI requires some more information, then they let the company know, and then the company needs to provide them with those documents.
If SEBI is satisfied with the DRHP and the Documents then SEBI gives the company approval for an IPO.
Once they receive an approval from the SEBI, the next thing they do is release a Red Herring prospectus. This prospectus contains various details of the IPO, like share price/price band, company’s performance in the past, how many shares will be offered, etc. This is majorly to create an interest within the potential investors.
The last step is when finally the IPO launches and then the bidding starts and the shares are started to being allotted. IPO is generally opened for 3 days.
IPO PROCESS FROM THE PERSPECTIVE OF THE INVESTORS-
Let us understand the process which an investor needs to go through while making/planning to invest in the upcoming IPO of a company-
When as a retail investor, you have planned to invest in the upcoming IPO of a company, clear this thing in mind that you can only buy the shares of that IPO when it is open for the investors.
Also, the main thing is that whether you are investing in an IPO or in a normal listed company, a Demat account is a necessity. It doesn’t matter if you are investing offline or online, but if you don’t have a Demat account you cannot invest. So make sure you have one, as shares directly get credited in your demat account.
As we know, there are two procedures for investing in an IPO, one is through the online mode and other is through the offline mode.
If you wish to go through the offline mode then firstly, you need to get an application form from the banks/brokerages that are involved in the upcoming IPO. After that just fill up that form and send that application form with a cheque for the bid amount to that specific bank/brokerage.
If you wish to go through the online mode, then visit the website of that specific bank or brokerage, fill in the details through their portal, transfer the amount through your bank and lastly submit your bid.
The procedure of a company to go public is quite tiresome as well, from the perspective of the company as to get an approval to file an IPO from SEBI is not that easy. Many companies who have gone through this process has stated that filing an IPO is not a cakewalk, thus it is a tiresome process. SEBI is quite strict with its policies if it sees any discrepancies they straightaway will reject a company from going public. Well, let us understand how before the approval an IPO works.
1. After the company has decided to launch its IPO, it needs to hire Investment Banks, who help in filing of an application for SEBI with all relevant details including the number of shares to be issued, the price set (in case of a fixed price IPO), previous records of the company, etc needs to very accurate.
2. Once all your documentation is verified by SEBI and after getting approval from SEBI, the company issues what is called a red herring prospectus, as stated above this contains information on its past records and details about the IPO.
3. After releasing the red herring prospectus, now the company will require someone who can manage the sale of that IPO and for this, the company contacts a lead manager, which can be from both, an investment bank or a brokerage firm.
4. Once they have found the lead manager who will manage the sales then that lead manager solicits bids for the IPO from investors.
5. Lastly, when the IPO goes live then the investors can subscribe to it and specify the amount they’d like to invest.
IPO consists of various terminologies which as an investor one should know and have an idea about. Below are some basic terminologies which will help you while investing-
An underwriter is commonly a financial organization like investment banks, which is in charge of conducting the IPO proceedings and recordings of the allotment of shares. Underwriters also help companies with drafting the DRHP (Draft Red Herring Prospectus). They also guide the company about the process of IPO.
A retail investor is common people, individuals like you.
Non-qualified Institutional Investors-
This includes a category of Corporates, Societies, NRIs etc.
Qualified Institutional Investors-
Qualified Institutional Investors or the QII is a category which includes financial institutions like the banks, brokerages and Foreign Institutional Investors (FII). These categories are listed as QII by SEBI.
Red Herring Prospectus-
It is a document which is published by the company for the public, it contains information about the company’s past performances, its management, financial statements etc.
This is the price of a single share offered in an IPO, which is generally fixed by the company. This pricing can be of two types, Fixed Price and Book Building. The former is when the price is fixed before the IPO opens, and the latter means the price which is set after the IPO has opened, depending upon the demand for the shares offered.
The primary market is defined as the initial sales or the initial transaction between the company and the public bidders.
This is the 2nd part where the public can directly purchase and sell the shares. The requirement of bidding on shares stops, once the IPO moves forwards to the secondary market.
The process of float happens when the number of shares is in circulation. In other words, this means the trading of a maximum volume of shares on a stock exchange.
Flipping is a process which is majorly discouraged by the underwriters. It is processed when investors buy and sell the share of an IPO on the very 1st day of trading when the demand is high and share price is inflated. This is not advisable to do, as this brings the share value down and thus, gives them a bad name.
Sometimes due to the oversupply and drop in share value, the underwriters here plays a major role and make the private investors sign an agreement for not selling their shares in the company for a specific period of time after the company enters in the stock exchange. This time span which is given to the investors is called the Lock-in period, during this period private investors cannot sell their shares.
This is when a stock is listed on the stock exchange based on the demand for the stock and thus this share price reaches the market and this is known as the Market Price.
The market price determines the market valuation of a company as through this you will know how much value the market is ascribing to the company.
Investment is itself a big step and finding that investment, where you have minimal risk, is quite tough. For that, a persona should itself be cautious and should know how to manage or minimalize risks for themselves during investment in an IPO
Below is the list of few Dos and Donts while planning for investing in an IPO.
THINGS YOU SHOULD DO/CONSIDER
This is the main thing which an investor should do. Before you plan to invest in an IPO make sure you do in-depth research on it. Learn about the company, know about its past performances, its financial records, its competitors, its product and services, its management etc. As this will help you determine what kind of a company it is, and whether its prospects are good or not, whether it will be able to perform well in the upcoming years. This is the best way for understanding whether an investment in a specific IPO is good or bad, and this way you will reduce the chances of making a bad investment.
GO THROUGH THE PROSPECTUS CAREFULLY-
This is another major thing you should do as understanding the prospectus is very important as it consists of detailed information of the company’s past financial records, its management, its present status and future prospects. All such information is very important, in such prospectus it will also be mentioned that how a company is planning to spend the raised money from the IPO. It will be good if the company is planning to expand with the raised money as this will benefit the investors also.
INSPECT THE UNDERWRITERS EFFICIENTLY-
Before investing in an IPO, after understanding the prospectus, make sure you get a piece of good information on the banks/brokerages that will act as the underwriters in order to conduct the IPO proceedings. Generally, it has been seen, that the big reputed banks and brokerages accept the companies on the basis of their financial health and long term prospects. They can be picky but there are few underwriters also, who brings in poorly performing companies to the market. Majorly this is done by the small brokerages and investment banks. This step is very crucial, so make sure you analyse the banks and brokerages also who will be working as the underwriter for a company planning to launch an IPO.
KEEP FOCUS ON THE ISSUE PRICE-
This step is also important as evaluating that at what price the shares are being offered is crucial. Evaluating this is quite easy, for this, you have to compare the share price of a listed company in the same sector or the same scale/business. You can also analyse its price to earnings ratio in order to asses that whether or not the share price is worth it or not.
THINGS YOU SHOULD NOT DO
FALLING FOR THE BRAND NAME-
Many times people get influenced by the brand name, and they think that this company is a reputed firm and thus they wish to invest in the IPO of that company. But wait, as they say, “Don’t judge a book by its cover”, the same way you can’t judge a company on the basis of its brand. Go through its financial records, analyse the company in and out and then when you truly feel that it has major growth potential then you can go for it.
DON’T LISTEN TO BROKERS/ FINANCIAL ADVISORIES-
Sometimes, in order to earn more brokerage charges, the brokerage firms will be on your life to buy the shares of a specific IPO of a company. They might tell you that according to their analysis this firm will do great in the near future etc. In this scenario, what is best for you as an investor is don’t listen to them. In the investment world, if you are investing in your own in the stock market, the only person you should listen to is you. On the basis of your assessment, your analysis you should make a decision, not if someone else is recommending you to do so.
FALLING FOR THE HYPE-
Investors many times, get influenced by the hype that is created by other people as well. Many people are like, this is a big company, this is a reputed company you should invest in this. But no, based on your assessment of the company’s prospectus you should invest, not because it’s too popular. For example, We all know that Cafe Coffee Day is a popular name, but its IPO was not that good. When its IPO was launched, people were so hyped to invest in it, that later the IPO was only subscribed by 14%. This was because few investors analysed deeply and go to know that IPO was primarily launched to clear the company’s debt and not for its further growth.
The process of IPO allotment is quite simple. If we are talking about the fixed-price process then all the bids are made on the fixed price only. Whereas in the case of Book-building process all the bids are placed within a price range and then a final price is fixed. This price band is generally made by the company. If the price of an IPO is less then it is called the Floor price. If the price of an IPO is more then it is called the Cap Price. Thus, many times when you think that there are chances that a particular IPO might be in high demand or over-subscribed, then it is a good time to bid for shares at the cut off price. If you choose the cut off price option while bidding for shares, you will get shares at the cut off price determined later on.
What will happen in case of oversubscription?
In the case of oversubscriptions, the companies start to distribute the shares among bidders if the number of bids exceeds the total number of shares on offer. The company be sure of distributing the shares proportionately among bidders based on the value of their individual bids. The categorization of IPO is generally done on 3 bases, one is for the institutional investors, second if for the non-institutional investors and lastly for the retail investors.
One thing which is the most important for people to remember is that in an IPO the shares of a company are sold on the basis of lots and not individually.
Usually, companies aim to try and ensure that every bidder gets at least 1 lot of the stock. This way the remaining lots can be divided among bidders, and that too proportionate to the number of lots they've bid for. If this is not possible, that is, if the number of bids is greater than the number of share lots, allotment is done by way of a computerised draw of lots.
Now since we have learned everything about the IPO, let us now look at how the companies and the public benefit from the IPOs-
For the Company
Long term gains -
As an investor, if the company fares well in the upcoming years then your stock value rises and thus you gain benefits. Not only this if the company makes a good profit then they might also give you dividends on the shares you hold. Although, this decision is completely under the favour of the board of directors of the company.