Types of Initial Public Offerings (IPOs) in India
Purchasing shares in Initial Public Offerings (IPOs) has a lot of benefits for investors. It allows them to become active stakeholders of an organisation and also get the right to dividends when the company offers the same in the future. Moreover, it is a great way to buy shares of businesses that have significant growth potential in the long run at a decent price.
In addition, there are different types of IPOs to which individuals can allocate their funds. So, if you are interested in investing in an IPO, give this blog a read.
What Is an IPO?
An IPO is a process by which a privately owned company becomes public by selling its shares to various types of investors. It helps businesses obtain capital that can assist in their future growth. For investors, it is an opportunity to add high-quality stocks to their portfolio that can provide significant profits in the future.
What are the Different Types of IPO?
In India, two types of IPOs are issued by companies:
- Fixed Price Issue
In this type of IPO, an organisation and its underwriters fix a price of the shares by assessing its existing value, liabilities, assets, risks, future prospects, and all other financial aspects. This helps them fix a value so that they can raise their target amount.
After determining the price, they provide a document that justifies it with all the quantitative and qualitative factors of the company. Once this issue closes, the organisation can determine the demand for its stocks in the market.
In case of a fixed price issue, investors do not have to wait till the allocation date in order to know the price for each share. It is declared by the company before the IPO launch, and an investor needs to pay the total price while subscribing.
Let’s take an example for better understanding.
Suppose there is a company called ABC Pvt. Ltd. that wants to go public to expand its business operations. So, it decides to raise capital via a fixed price IPO and hires a merchant banker to analyse its financial condition.
After the assessment, the banker and the organisation decide to set the offer prices at ₹2,000/share. The company then submits an IPO application to the Securities and Exchange Board of India (SEBI), with a very important document called Draft Red Herring Prospectus (DRHP). It contains crucial information about this company’s management, finances, risks, reasons for going public and more.
If SEBI determines this DRHP to be in line with its requirements, ABC Pvt. Ltd. gets permission to list itself on the stock exchange and promote its IPO launch to attract investors. Investors who want to purchase shares in the IPO round will have to pay the entire amount while subscribing.
- Book Building Issue
For a book building issue IPO, there is a price band in which the highest limit is known as the ‘cap price’, while the lowest limit is called ‘floor price’. This price range is generally 20% and is printed in the DRHP, and an investor can bid on the quantity and price of shares that he/she would like to pay. This concept is widely used in developed nations and it is new to our country.
The share prices depend on the total number of bids, and if there is an oversubscription, the company offers them at the cap price.
In this type of IPO, a company announces the total number of shares that it plans to offer. It provides information to the public and the SEBI on the stakeholders who are selling their shares. Moreover, an investor only needs to pay if shares get allotted to him/her.
To facilitate a better understanding of this type of IPO, let’s take the help of an example:
Suppose a firm named XYZ Ltd. wants to raise funds via an IPO offering. It chooses to do so via the book building issue and hires a merchant banker to conduct an assessment of the organisation’s financial condition.
After the calculation and analysis phase, let’s assume this corporation decides to issue 12,00,000 shares with a price band of ₹2000 to ₹2500. In this case, the cut-off price is ₹2500 while the floor price is ₹2000.
Now, after the IPO subscription window ends, the business will review the bids. They may be as follows:
- 3,00,000 bids for ₹1,500
- 5,00,000 bids for ₹1,600
- 7,00,000 bids for ₹2,000
- 6,00,000 bids for ₹2,500
As the offer for 12,00,000 shares is at or above ₹2,000, investors who bid below this amount will not receive any shares.
What Are the Key Differences Between a Fixed Price Issue and a Book Building Issue?
The key differences between a fixed price issue and a book building issue are as follows:
|Parameter||Fixed Price Issue||Book Building Issue|
|Share Price||It is fixed and is mentioned in the DRHP.||It is in a range that is fixed after the IPO offer closes.|
|Demand||The demand will vary according to the valuation decided by the company. High demand can be seen if shares are offered at an attractive valuation.||This procedure is advantageous for both the investor and the company as the share price is determined as per the equilibrium between supply and demand.|
|Subscription||Subscription status is updated every day till the subscription window closes.||Subscription status is updated every single day of the offering.|
|Payment||For subscribing, an individual has to pay the entire amount.||An investor has to pay the subscription amount as per the bidding price.|
|Reservation||Investments below ₹2 Lakhs – 50%For other Investors – 50%||Small Investors – 35%Qualified Institutional Buyers (QIBs) – 50%Other Investors – 15%|
Investing in IPOs is an excellent way for investors to gain quick returns, however, since it is the first time the company is going public, it has its own risks. Before investing, please ensure to conduct thorough market research on the company’s fundamentals and consult your financial advisor.
Frequently Asked Questions
What are the eligibility criteria for investing in an IPO?
To invest in an IPO, you need to have a PAN card, a Demat account, and a trading account. For a first-time IPO investor, it is advisable to open a trading account with your brokerage firm while opening a Demat account.
What are the risks of investing in IPOs?
Some of the risks in the case of IPO investments are that external factors can influence the share prices and there is no guarantee that you will receive the shares. Moreover, a certain category of investors cannot access the shares for a certain period of time.
What are the things to check before investing in an IPO?
Draft Red Herring Prospectus (DRHP), business model, company valuation, future prospects, strengths and weaknesses, etc., are some of the things that you must check about a company before investing in its IPO.
Can a company reject my IPO application?
Yes, a company can reject your IPO application if you apply multiple times from one PAN number. Moreover, there can be other reasons behind the rejection like providing invalid or wrong information, mismatching your name on your PAN card or bank account, etc.