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Introuction to IPO
Initial Public Offering (IPO) is when a privately-owned company sells its shares to the public for the first time. This means that investors like you can buy stock in the company and become shareholders.
While you become a stakeholder, the firm gets money from selling these shares, which they can use to grow the business or pay off debts. It’s like opening a store to everyone in public instead of giving limited access to a small group of people who were allowed to invest earlier.
When a company decides to go public, it generally hires an investment bank to underwrite the IPO. Although it is a multi-step process, the crux lies in pricing the shares and finding buyers.
Once the offering is completed, the company’s shares are traded on a stock exchange and publicly traded. When an IPO is announced in India, you might see their shares on BSE or NSE. Exciting, right?
IPOs are considered a long-term way of fundraising and can give the company access to a large pool of capital. This pool can then be utilised to repay debt, pursue expansion projects, fund marketing or advertising costs, and monetise the investments of early private investors.
What Is the IPO Process?
Ever heard of the saying – there’s more to this than meets the eye? As investors, you are interested in the IPO share price. But there is a lot that goes behind the scenes.
Here are 7 steps involved behind a typical IPO –
Step 1: Preparation
The company will begin by preparing financial statements, business plans, and other documents to provide relevant information to potential investors. They will also hire an investment bank to act as an underwriter for the IPO. An IPO underwriter will help decide the share price and attract potential buyers.
Step 2: SEBI Registration
The company will file a registration statement with the Securities and Exchange Board of India (SEBI) to provide information about the company’s financial financials, risk factors, utilisation of capital raised through IPO, management, description of business, etc. All these details are clubbed to create a Red Herring Prospectus (RHP).
Investors note: Creating an RHP is mandatory for all companies looking to go public under the Companies Act.
Step 3: Watchdog’s Verification
Not just registration but approval by the stock exchange regulator is also needed for a company to issue an IPO. Sebi will verify all financials disclosed in the RHP before giving the firm the go-ahead.
Step 4: Applying to Stock Exchange
After ticking off Sebi’s approval, the firm will have to write an application to a recognised stock exchange like BSE or NSE. Only by doing so will investors get notified about their new offering.
Step 5: Roadshows
Not Dream11, but a roadshow is a promotional activity to create buzz around the IPO. Typically, the company’s management team and the underwriters hold meetings with institutional investors and analysts to generate interest in the IPO. Hosting QnAs, presentations, virtual discussions, etc., are all steps to bring the IPO news into the public’s radar. Otherwise, why would the public be interested in investing in the firm?
Step 6: Pricing
After completing the roadshows and other promotional activities, the underwriters will work with the company to determine the price of the shares. Investors can then decide to bid within the price bracket or lot size (minimum shares to be purchased) decided by the company.
Step 7: Allotment Time
After the deadline for bidding, the underwriters will allocate shares to each investor. In case of over-subscription, the firm might allow you partial claims, i.e., shares less than the number you had applied for, during the bidding process.
After the shares have been allotted and allocated, they will be listed on a stock exchange and made available for trading. The company will now officially be considered a “publicly-traded company”.
After the IPO, the company will file regular reports with Sebi and conduct annual shareholder meetings or, at times, award dividends.
What Are Key IPO Terms?
You may encounter unfamiliar yet important terms when an IPO is announced. These are critical IPO jargon you must know before bidding your money. Some keywords mentioned in an IPO are –
- Prospectus: A document that provides detailed information about the company, its financial condition, and the terms of the offering to potential investors.
- Underwriting: The process by which an investment bank acts as an intermediary between a company issuing securities and the public. The bank helps the company determine the price of the securities and finds buyers for them.
- Lead Underwriter: The investment bank that takes the lead role in managing the IPO process.
- Book-Building: The process by which the investment bank and the company determine the price of the securities by gauging demand from investors.
- Green Shoe Option: An over-allotment option that allows underwriters to sell additional shares if demand for the stock is higher than expected.
- Lock-up Period: The period, typically 180 days after the IPO, during which company insiders are prohibited from selling their shares of the stock.
- Initial Shareholders: Private investors or the management team that held shares in the company before the IPO.
- Underpricing: pricing the shares at a lower price than the market value, where the company’s shares are expected to trade on the market.
- Overpricing: Pricing the shares at a higher price than the market value, where the company’s shares are expected to trade on the market.
- Price Band: The price range within which investors can bid for IPO shares. The company jointly sets this range and the underwriters involved.
- Floor Price: The minimum price at which an investor can bid for an IPO share. In the case of a price band, the floor price represents the lower limit of the range.
- Issue Price: Also known as offer price, it is the value at which shares are allotted to each investor. While each investor category is issued IPO shares at a different value, it is usually the lowest for individual investors.
- Cut-off Price: This is the lowest price at which shares are allotted to an investor in an IPO. This value is commonly reserved for retail or individual investors. If your bidding price exceeds the cut-off value, you will receive the difference as a refund.
- Dilution: The reduction of an individual shareholder’s ownership percentage in a company due to the issuance of new shares.
- Pre-IPO: The period leading up to the IPO.
- Post-IPO: The period of time after the IPO.
- Shelf Registration: A method of registering securities with the regulatory body that allows a company to sell securities from time to time over a period of up to three years (4 years in India) without having to file a new registration statement each time.
How To Analyse An IPO?
When an IPO is announced, a question pops up: Is the IPO worth investing in? Of course, you are not Nostradamus to predict the stock’s performance. Will a coin toss work? Or just following the footsteps of the crowd? Of course not. But the analysis will.
Here are some key factors to consider while analysing an IPO. You might just be able to predict the IPO’s success rate:
Financials: Review the company’s past financial statements, including income statements, balance sheets, and cash flow statements. If these sound too difficult, there is a more straightforward option – check for past quarterly performance and year-on-year growth. These figures will help you determine whether or not the firm will continue to grow. Usually, promising future growth hints more toward a good IPO performance.
Industry: Research the industry or domain in which the company operates. If the industry is dying, chances are the company will only survive if it diversifies or adapts. You can also look at upcoming trends in the industry and whether the company is adopting them. How adaptive and resilient a company is often reflected in its future performance.
Competition: Another critical factor to consider is the company’s competition, along with its market share, products, and services. A more significant market share indicates that the company enjoys more market dominance.
Management: If in-depth research is your forte as an investor, try looking at the company’s management team and board of directors along with their experience and track record. Notable figures attached to the company are enough to build trust among investors, especially when participating in the IPO.
Valuation: Try to compare the company’s valuation to that of its peers to determine whether or not the IPO price is reasonable. Also, keep track of what reputed analysts feel about the proposed IPO valuation. If the valuation is fair, the IPO shares may perform poorly on the stock market.
The Red Herring Prospectus (RHP) includes most of the abovementioned aspects. It’s always important to read the company’s prospectus before making investment decisions. Unleash the detective in you to avoid getting Sherlocked by the IPO later! Or you can seek advice from your financial advisor.
6 Myths Around IPOs
With the string of IPOs being announced lately, there is a massive space for myths and misconceptions. Best to make sure that you do not fall prey to them. Here’s a look at some common myths around IPOs –
Myth 1: IPOs always result in a big windfall or a jackpot for early investors!
While some IPOs result in significant gains for early investors, not all IPOs perform well. Some may result in losses for investors. The best way to predict a profit or loss is by digging through the company’s financials. After all, the RHP is available for investors free of charge online.
Myth 2: A company goes public solely to raise money
While raising capital is one reason companies go public, an IPO also amounts to good press. Other causes include increasing the company’s visibility, prestige, access to capital markets, etc.
Myth 3: Going public means the company is making huge profits
Going public does not guarantee that a company is profitable. Many companies go public while they are barely making ends meet. It may be hard to believe, but going public is also a way to pay off debt.
Myth 4: Publicly traded equals 100 per cent transparency
Going public requires a company to disclose its financials to the public. However, this does not indicate that the firm has become more transparent after its IPO.
Myth 5: The IPO process is faster compared to private fundraising
Often, the process of going public takes months or even years to prepare for the IPO process. Even approvals from the regulator take time. You must know a lot of legal and financial paperwork to start the process.
Thus, while it may look faster than some fundraising methods, there are better ways to raise capital.
Myth 6: Stock price will rise immediately after the IPO
An IPO can sometimes result in a bullish performance in the initial days. But the stock market is highly volatile and responsive to its environment and global conditions. So, chances are that this bullish run will only last for a short period.
In the longer run, however, the shares may not even perform well in the long term. Thus, this statement should only be treated as an observation, not a fact embedded in concrete.
- Initial Public Offering (IPO) is when a privately-owned company sells its shares to the public for the first time. This means that investors like you can buy stock in the company and become shareholders.
- When a company decides to go public, it generally hires an investment bank to underwrite the IPO. Although it is a multi-step process, the crux lies in pricing the shares and finding buyers.
- The Red Herring Prospectus (RHP) includes most IPO details like financials, competition, industry, valuation, etc. It’s always important to read the company’s prospectus before making investment decisions.
To invest in an Indian IPO, individuals aged 18 and above need a bank account with sufficient funds, a Demat account from a registered Depository Participant, a trading account for stock buying and selling, and a PAN number. The associated bank account must support ASBA, UPI services, and online banking.
A company can decide to go public and launch an IPO when it meets all the eligibility requirements of the SEBI. Additionally, the company must also be capable of meeting financial obligations towards investors. An uptrending economy where investors have a positive outlook can make an IPO more lucrative.
Book building and fixed-price IPOs are two common methods.
Book building: Determining the price based on the demand for shares at various price levels within the given range, during the bidding process.
Fixed price IPO: Underwriters decide the price of shares before launching the IPO, based on the company’s background and performance, the industry and the prevailing economic situation.
The primary and secondary markets are both risky due to volatility. However, IPOs are riskier since companies are new and reactive to market conditions, making these stocks more volatile. But, they may offer higher returns.
So, the choice must purely depend on the investor’s risk appetite and financial goals.