What are initial public offerings?

An Initial Public Offering (IPO) is Dalal street’s version of a launch party. It is the first time that a privately held company becomes a public company. When a company goes public it offers to sell shares of their company to investors on a stock exchange like National Stock Exchange (NSE) or Bombay Stock Exchange (BSE). Investors who purchase these shares become part owners of the business. You can buy shares of a company that’s already listed, through a stockbroker, this is called buying stocks from the secondary market, where the actual trading of stocks take place. When you buy stocks directly from the company when it comes out with an IPO, it is called primary market.

Why do companies come out with an IPO?

The amount that the company collects from investors who have purchased their shares can be used for expansion purposes, buying machinery/land or to repay any debt. The details of the IPO are given in the Red Herring Prospectus which is available on SEBI’s website. Not every private company can come up with an IPO. SEBI has laid down some guidelines. You can read about the Eligibility criteria to get listed on NSE on this link
https://www.nseindia.com/getting_listed/content/eligibility_criteria.htm

How does the entire procedure of an IPO take place?

The company hires an investment bank to handle the entire process of an IPO. The investment bank and the company decide the amount of funds to be raised, type of securities to be issued and other necessary details.

Investment bank applies to SEBI with its registration statement. The statement contains details about the company’s management, financial statements, where the money raised from IPO will be used, any legal problem the company is in, etc. SEBI then investigates all details and makes sure all necessary information is disclosed. Once SEBI approves the statement, a date is decided when the stock will be offered to the public.
Investment bank prepares a Red herring prospectus which contains all details of the company. Management of the company, their future plans, financial statements and size of the IPO are also mentioned in the Red herring prospectus, which is then marketed on all newspapers, television channels to investors so that they purchase the IPO. This prospectus is also called Offer document.
The next step is fixing a price for the IPO at which investors will invest their money. Investment bank will fix a price band, for e.g. 950-1000 and investors will bid in this range, where 950 is called the floor price and 1000 is the cap price. Investors can bid for a period of around 3-7 days. This entire process is called book building. The shares are then allotted to the successful bidders and remaining bidders get the refund. Note that while investing in IPO’s you need to invest in lots. Say if you bid at a price of 1000, company will fix the lot size at 14, so you need to buy 14 shares and pay 14,000 Rs, if you want to buy 2 lots you have to pay 28,000 Rs
As investors bid at various prices, the company will fix one price around which most investors have done bidding and the company is listed at the place on the stock exchange and then starts trading.

Categories of investors in IPO

Qualified institutional buyers (QBI’s):

These included all the mutual fund companies, pension funds, provident funds, insurance companies etc. These set of investors have a huge capital to invest. There is a specific quota reserved for all investors in IPO’s and QBI’s are allotted maximum quota of 50%

Non-institutional investors or high net worth individuals (HNI):

They include individual investors, NRI etc. When you bid for an amount of more than 2 Lakh Rs in an IPO you are included in this category. The quota reserved for this category is 15%.

Retail investors:

Retail investors are the common investors who bid only up to an amount of 2 Lakh Rs. The quota reserve for this category is 35%.

Common terminologies used in IPO

Price band:

The price range within which investors can bid for IPO shares. For e.g. if price band has been fixed at 850-900, investors must bid within the given price bank only.

Book building process:

The process of deciding the issue price of IPO is called the book building process. The issue price will be closer to the upper end of the band if investors have shown strong interest in the IPO and bid high. For e.g.: If the price band is set at 800-850 and investors bid high, the issue price will be set at 850 Rs and if they bid low it will be issued at the lower end of the price band.

Offer date:

Offer date is also known as the opening day of the IPO

Lot size:

The minimum number of shares you can bid for an IPO. If you want to bid more it must be in multiples of the lot size. For e.g. if the lot size of an IPO is 1500 shares and you want to bid more, it must be in multiples such as 1500, 3000, 4500.

Oversubscribed:

An IPO is oversubscribed if investors have bid more shares than offered by company.

Undersubscribed:

An IPO is undersubscribed if investors have bid less shares than offered by company.

Listing date:

This is the date that the IPO starts trading in the stock exchange. You can buy the shares if you did not receive in the IPO or sell shares if you received.