An Initial Public Offering (IPO), referred to simply as an "offering" or "flotation", is when a company (called the issuer) issues common stock or shares to the public for the first time.
The term Initial Public Offering (IPO) has been a buzzword amongst the investors for decades. It is the process where a privately held company becomes a publicly traded company with the initial sale of its stock. An IPO is a tool that companies use to secure capital through investments for future use. In most instances, this investment is used to expand or improve the business. Market experts provide ratings for different upcoming IPOs which tend to be one of the reasons to subscribe for retail investors.
Market Regulator, Securities and Exchange Board of India (SEBI) says on its website: “...Irrespective of the grade obtained by the issuer, the investor needs to make his/her own independent decision regarding investing in any issue after studying the contents of the prospectus, including risk factors, carefully.” In other words, IPO rating is, at the most, an add-on.
Indian Securities market has witnessed introduction of some important institutional mechanisms in the early part of this millennium in the realms of primary market & secondary market as well. These initiatives were aimed at bringing in the best practices and making the Indian Capital Market comparable to the global markets. An important reform in the primary market sphere is the introduction of Book Building process of issuing shares.
Book Building involves soliciting from the professional investors how many shares they are willing to buy and at what price. On the basis of the resulting demand curve, the firm and its investment bankers determine the IPO price. Book Building process helps the Issuer not only to determine the demand but also aids the process of ‘price discovery’ i.e. the price at which shares shall be issued will be determined by the demand and supply forces of the market. A retail investor can bid in a book-built issue for a value not more than `2,00,000. Any bid made in excess of this will be considered in the HNI category.
A corporate may raise capital in the primary market by way of an Initial Public Offer (IPO), rights issue or private placement. An IPO is the selling of securities to the public in the primary market. It is the largest source of funds with long or indefinite maturity for the company. Requirement of funds in order to finance the business activities motivates entrepreneurs to approach the new issue market. Initial Public Offer (IPO) is a route for a company to raise capital from investors to meet the expenses of its projects and to get a global exposure by getting listed in the Stock Exchange.
IPOs are issued by smaller, younger companies seeking capital to expand, as well as by large privately owned companies looking to expand & become publicly traded. When a company lists its securities on a public exchange, the money paid by investors for the newly-issued shares goes directly to the company (in contrast to a later trade of shares on the exchange, where the money passes between investors). An IPO, therefore, allows a company to tap a wide pool of investors to provide it with capital for future growth, repayment of debt or working capital.
IPO can be used as both a financing strategy and an exit strategy. In a financing strategy the main purpose of the IPO is to raise funds for the company. In an exit strategy for existing investors, IPOs may be used to offload equity holdings to the public through a public issue. A company selling common shares is never required to repay the capital to investors. Once a company is listed, it is able to issue additional common shares via a secondary offering, thereby again providing itself with capital for expansion without incurring any debt. This ability to quickly raise large amounts of capital from the market is a key reason many companies seek to go public.
There are several benefits for being a public company, namely:
Bolstering and diversifying equity base
Enabling cheaper access to capital
Exposure, prestige and public image
Attracting and retaining better management and employees through liquid equity participation
Facilitating acquisitions
Creating multiple financing opportunities: equity, convertible debt, cheaper bank loans, etc.
Increased liquidity for equity holder
You can apply for an IPO through online as well as offline mode:
a) Online Mode:
To apply in IPO's online, an investor has to open a demat account / trading account with financial institution that provide this facility. Most Nationalized Banks and Stock Brokers in India offer the facility to apply IPO's online. Once demat & trading account is opened, one should follow below steps to apply online:
1. First login in your trading account and select the IPO you wish to invest in.
2. Transfer funds from your bank account to your trading account.
3. Select the number of shares you want to apply for and the price at which you want to bid for (or use cut off option) and then press submit button.
If you get the allotment, the shares will be credited to your demat account. The remaining money will be credited to your bank account through ECS. The most convenient way to apply in an IPO online is using 3-in-1 account (bank account, demat account & trading account) offered by banks. The process of applying IPO's online is extremely convenient.
b) Offline Mode:
You can apply in any public issue through your bank account. You have to fill the details such as your Name, PAN number, Demat account number, bid quantity, bid price and other relevant details and submit the "Application Supported by Blocked Amount" (ASBA) application form to the banking branch which has been designated to act as a Self Certified Syndicate Banks (SCSB) for providing ASBA services. After the submission of your application, the bank will upload the details of the application in the bidding platform. Ensure that you fill the correct details in the form, otherwise your application may get rejected.
Steps in an IPO Process
Let us now have a look at how an Initial Public Offering process is initiated and reaches its conclusion. The entire process is regulated by the 'Securities and Exchange Board of India (SEBI), to prevent the possibility of a fraud and safeguard investor interest.
Selection of Investment Bank
The first thing that company management must do when they have taken a unanimous decision to go public is to find an investment bank or a conglomerate of investment banks that will act as underwriters on behalf of the company. Underwriter's buy the shares of the company and resell them to the general public. The company must also hire lawyers that can guide them through the legal maze that an IPO setup can be. It must be ready with detailed financial records for intensive fiscal health scrutiny that SEBI would perform. Some companies may also opt to directly sell their shares through the stock market, but most prefer going through the underwriters.
Step 1: Preparation of Registration Statement
To begin an IPO process, the company involved must submit a registration statement to the SEBI, which includes a detailed report of its fiscal health and business plans. SEBI scrutinizes this report and does its own background check of the company. It must also see that registration statement fulfils all the mandatory requirements and satisfies all rules and regulations.
Step 2: Getting the Prospectus Ready
While awaiting the approval, the company, with assistance from the underwriters, must create a preliminary 'Red Herring' prospectus. It includes detailed financial records, future plans and the specification of expected share price range. This prospectus is meant for prospective investors who would be interested in buying the stock. It also has a legal warning about the IPO pending SEBI approval.
Step 3: The Roadshow
Once the prospectus is ready, underwriters and company officials go on countrywide 'roadshows', visiting the major trade hubs and promote the company's IPO among select few private buyers (Usually corporates or HNIs). They are fed with detailed information regarding company's future plans and growth potential. They get a feel of investor response through these tours and try to woo big investors.
Step 4: SEBI Approval & Go ahead
Once SEBI is satisfied with the registration statement, it declares the statement to be effective, giving a go ahead for the IPO to happen and a date to be fixed for the same. Sometimes it asks for amendments to be made before giving its approval. The prospectus cannot be given to the public without the amendments suggested by SEBI. The company needs to select a stock exchange where it intends to sell its shares and get listed.
Step 5: Deciding On Price Band & Share Number
After the SEBI approval, the company, with assistance from the underwriters decide on the final price band of the shares and also decide the number of shares to be sold.
There are two types of issues: Fixed Price and Book Building
Fixed Price – In a Fixed price issue – the company decides the price of the share issue and the number of shares being sold. Ex: ABC Ltd public issue of 10 lakh shares of face value `10/- each at a premium of `55/- each is available to the public thereby generating `6.5 Crores.
Book Building – A Book building issue helps the company discover the price of the issue. The company decides a price band and it gives the investor an option to choose the price at which he/she wishes to bid for the company shares. Ex: ABC Ltd issue of 10 lakh shares of face value `10/- each at a price band of `60 to `70 is available to the public thereby generating up-to `7 Crores. Here the amount generated through the issue would depend on the highest amount bid by most investors.
Step 6: Available to Public for Purchase
On the dates mentioned in the prospectus, the shares are available to public. Investors can fill out the IPO form and specify the price at which they wish to make the purchase and submit the application.
Step 7: Issue Price Determination & Share Allotment
Once the subscription period is over, members of the underwriting banks, share issuing company etc. will meet and determine the price at which shares are to be allotted to the prospective investors. The price would be directly determined by the demand and the bid price quoted by investors. Once the price is finalized, shares are allotted to investors based on the bid amounts and the shares available.
Note: In case of oversubscribed issues, shares are not allotted to all applicants.
Step 8: Listing & Unblocking of funds
The last step is the listing in the Stock Exchanges. Investors who have applied through ASBA & to whom shares were allotted would get the shares credited to their DEMAT accounts & their funds getting debited from their bank account or else for those investors to whom the shares were not allotted, funds would get unblocked in their bank account.
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