Basics of Initial Public Offering (IPO) in India ￼
An IPO is an integral part of the Indian equity markets because it helps companies to raise funds. With IPOs, companies can unlock their full potential as it allows them to get the capital necessary for their plans of expansion, research, debt repayment, or offer exit to the current investors. IPOs offers people the opportunity to create wealth by investing in them.
In this blog, we will discuss the basic details of an IPO.
What Is an IPO?
IPO is the process by which a company offers shares to the public for the first time. The process is also referred to as “going public”. This is because the company will have public participation after it offers its shares to retail investors & will be listed on the exchange.
Through this process, companies raise equity capital from the primary market and get listed on stock exchanges. Thereafter, investors can freely buy and sell shares on the secondary market.
Types of IPO
Before going public, a company employs investment banks to determine the price of its shares. There are two types of IPO—fixed price issue and book-building issue. Let us explore their details:
- Fixed Price Issue
In a fixed price issue, investors are well aware of the price of a share before the IPO process of the company begins. While subscribing to a company’s IPO, they need to pay the total fixed price for the applied shares.
- Book Building Issue
In a book-building issue, the company releases the price of shares during the IPO process. Though the company does not set any fixed price, it sets a price band. The lowest price of this band is called ‘floor price’ and the highest is called ‘cap price’.
In the book-building method, investors are required to bid for shares within a specific time before a company decides the price. The bidding takes place within the price band that can have a maximum limit of 20%. It is important for the company to inform the investors of the total number of shares it intends to offer, even though the final price is set based on the bids.
When Can a Company File an IPO?
The prerequisite conditions that must be satisfied for a company to file an IPO as per SEBI are:
- It has an average operating profit of a minimum ₹15 crores for at least 3 years out of the past 5 years.
- It must have net tangible assets of a minimum of ₹3 crores every year for the previous 3 years of which not more than 50% must be held in form of cash and cash equivalents.
- It has a net worth of at least ₹1 crore in each of the preceding three full years
- If it has changed its name within the last year, at least fifty percent of the revenue, for the preceding one full year has been earned by it from the activity indicated by its new name.
- If a company does not fulfill the aforementioned criteria but still wishes to file for an IPO, it has to opt for a book-building issue and reserve 75% of its shares for Qualified Institutional Investors (QIIs).
How Do IPOs Work in India?
In India, the Securities Exchange Board of India (SEBI) has provided a list of steps companies need to follow to get listed on stock exchanges.
Let us take a brief look at how an IPO process works:
Step 1: Hiring an Investment Bank
The IPO process requires a thorough analysis of various financial factors. So, companies hire investment banks and underwriters for their services.
These financial entities work as a bridge between the issuer company and its future investors. They study the financial health of a company, analyse its assets and liabilities, and formulate a plan to address its financial requirements.
The issuer company and one or more investment banks will sign an agreement that will contain details of the shares offered, the amount a company wishes to raise, and other crucial details.
Step 2: Registration for IPO with the SEBI
Every company aiming to go public has to first prepare and file a registration statement under the Indian Companies Act along with a prospectus called Draft Red Herring Prospectus (DRHP). The first draft of the prospectus is referred to as DRHP because it is not the final prospectus that contains some additional details.
The DRHP contains crucial details about risk factors that can affect a company’s financial position, industry & business descriptions, management details, financial data, and legal and other miscellaneous information and use of proceeds
This document must be submitted to the local Registrar of Companies (RoC) at least 3 days before the offer goes public.
Step 3: SEBI Verification
After a company submits its registration statement and DRHP to the Registrar of Companies, it can proceed with making a formal application to SEBI. The market regulator will verify every piece of information and facts that a company has disclosed in its IPO application. If it approves the application, the company will be able to announce a date to launch its IPO.
Step 4: Application to Stock Exchanges
Now, the company has to decide and apply to stock exchanges where it wants to get listed. Both the NSE (National Stock Exchange) and the BSE (Bombay Stock Exchange) have their own list of criteria that a company must fulfill to be listed.
Step 5: Marketing
Next comes the marketing phase where the company will build public interest for its IPO. Company executives will travel all over the country marketing and promoting the IPO among potential investors including Qualified Institutional Buyers (QIBs) in crucial financial centers. In order to create a positive image of the company, they present facts and figures to attract as many investors as possible.
Step 6: Setting the Pricing
To decide on the pricing of an issue, a company seeks the help of an investment banker. The price of a public offering will be fixed if a company opts for a fixed-price IPO. Otherwise, for a book-building issue, a company will only set a price band for investors to put in their bids.
Step 7: Allotment of Shares
Finally, the bidding process takes place. Investors will need to place bids within the company’s quoted lot price. This process is typically open for 3 to 5 working days and investors can alter their bids within this specified time frame. The company decides the cut-off price after the bidding process is over and this is the final price at which an issue gets sold.
After an IPO closes, the company along with its investment banks and underwriters determines the number of shares that can be allotted to every applicant. In the case of IPO oversubscription, i.e. if the IPO receives more bids than the total number of shares that were offered, applicants will receive only a portion of the bids fulfilled within 10 working days or will not receive shares at all.
How Are IPOs Beneficial for Companies?
Listed below are the benefits of IPO for companies:
- Issuer companies offer shares to the public through IPO to get required funds. It is an easy way for a growth-driven company to raise huge capital for its operation.
- Through an IPO, a company evaluates its prospects. The process also enables its early investors to sell off their stakes and earn profits. When the value of shares rises, the net worth of the investors rises as well.
- An IPO acts as a valuable leverage for a company when it approaches financial institutions and negotiates for mergers and acquisitions and loan terms. Recognized companies listed on stock exchanges can receive funds at low-interest rates.
- Through an IPO, a private company gets listed on stock exchanges for the first time which increases its credibility. Moreover, upon getting listed on stock exchanges, a company is supposed to be accountable to its numerous shareholders and so, people perceive it to be more responsible.
How Can Investors Benefit from IPOs?
Given below are ways you can benefit from IPOs as an investor:
- You will receive a first-mover advantage, especially when reputed companies announce an IPO. This is primarily because you might get the opportunity to purchase shares at a reasonable valuation in the primary market. But, it will not be the case when shares reach the secondary market because their prices will rise.
- You will get a chance to earn good returns in the long term, especially if the company does well and has the potential to grow.
- If you are an investor interested to make quick gains, you can benefit from listing gains by purchasing shares in the IPO.
Knowing about the basic details of an IPO would help us to understand how a company raises equity capital from the market. If a company wishes to get listed on stock exchanges, it has to go through the IPO process. For investors, IPOs offer a way to get a first-mover advantage and own stocks of a reputable company at a reasonable price.
Frequently Asked Questions
How do shares affect a company’s ownership?
Every shareholder is a part owner of a company. Their ownership is in proportion to the percentage of shares they hold. For instance, suppose you hold 500 shares of Company ABC and it has 50000 shares outstanding. This means that you own 1% of the company.
What are the main differences between IPOs through book building and fixed-price public issues?
When a company offers its shares through a book-building issue, the share price is not fixed but there is a pre determined price range. But, when shares are offered through fixed-price public issues, share prices are predetermined and investors will be offered shares at that price. Moreover, people come to know of the demand for shares every day when it comes to book-building issues. With a fixed price issue, they come to know of the demand only after the IPO closes.
Can one use an open outcry system for book building?
One cannot use an open outcry system for book-building issues. SEBI has mandated that companies can use only electronically linked transparent facilities for book building.
For how many days will an IPO remain open for the public?
Generally, companies have to keep IPOs open for a minimum of three working days. This cannot exceed more than 10 working days. If the price band undergoes revision, it can be extended further by 3 days.