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What Is An Initial Public Offering (IPO)?

The first time a Company sells its stock to the public is known as an initial public offer. These are mainly launched by Companies which are new, but have a very sound business model and see vast scope for expansion in their business.

An Initial Public Offering could also be launched by a Company which has been in business for a while but wants to raise additional capital by selling part of its ownership to the public. The Company launches an IPO which is called "Going Public" and raises capital by selling the stake in the Company to the public.

What are Qualified Institutional Buyers?

The Company first targets people or institutions with a lot of money. These are called Qualified Institutional Buyers.

Mutual fund houses, Banks, pension funds, Insurers and even venture capital funds are qualified institutional buyers. At least 60% of the size of the issue needs to be subscribed (offered) to the Qualified Institutional Buyers if the price is decided by the book building method.

Why invest in IPO

Great Growth Opportunity

IPO gives you an opportunity to invest, right at the time the Company is listed. Ride on the growth of the Company and earn good returns.

Ride the Stock Market

IPO's are launched when there is a boom in the stock market. You can ride the bull if you invest in a good IPO.

 

Not all IPO's are Risky

Some IPO's carry risk, some do not. If you do your research, you can invest in good IPO's and get good returns at a lower risk.

Buy Low Sell High

If you invest in a good IPO, you automatically invest with the buy low, sell high approach. Buying low and selling high, gives good profit.

What is an anchor investor?

Anchor investors are a part of the qualified institutional buyers (QIB) and aid the price discovery process .Before the book building process is launched, the floor price and the cap price need to be determined. The QIB's and the anchor investors help to fix these prices.

In any field especially business, big names and big reputations serve as a boost to investments .In the same way anchor investors serve as an anchor or a support to the IPO. According to SEBI rules and guidelines, anchor investors need to stay invested for a period of at least 30 days. This protects retail investors from a sharp fall in prices due to excessive selling by the anchor investors.

Methods to price an IPO

Book Building Method

The method of price discovery (Finding the prices of the equity shares of the Company), is called book building. The optimum prices of the shares of the Company have to be fixed through a process known as book building.

A price range known as a price band is decided by the Company. It has a lower limit and an upper limit .The lower price (The shares will not be offered at a price lower than this), is called the floor price.

The upper price (The upper limit of the pricing of the shares), is called the ceiling price. Shares of the Company are offered within the price band.

You can bid only between the floor price and the ceiling price. The issue is then closed for subscription. The cut off price is then decided by the Company issuing the shares and the lead manager to the issue, based on the interest and the appetite of the investors to the equity (share) issue by the Company.

All investors who have submitted bids at and above the cut off price, are able to procure the shares of the Company. If you are a retail investor, then you can also apply at the cut off price (you are ready to purchase at the price decided by the Company and the lead manager to the issue).

If you have applied at the ceiling price and the cut off price is less than the ceiling price, then the excess money is refunded to your account.

 

Concepts & FAQ's IPOs

What is an IPO?

An Initial Public Offer (IPO) is the selling of securities to the public in the primary market. It is when an unlisted company makes either a fresh issue of securities or an offer for sale of its existing securities or both for the first time to the public. This paves way for listing and trading of the issuer's securities.

Why is an IPO offered?

It all began with the Dutch East India Company in 1602 and even today the sole objective of an IPO is to maximize value for its stakeholders. 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. An IPO, therefore, allows a company to tap a wide pool of investors to provide itself with capital for future growth, repayment of debt or working capital. A company selling common shares is never required to repay the capital to investors.

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Why should one invest in an IPO?

  • An attractively priced IPO gets a good response from investors as the chances of gains on listing are high.

  • Book building method to fix the price gives investors an opportunity to choose the price they are willing to pay. Book building is a price discovery mechanism in order to fix the price of the IPO. The underwriter specifies the floor cap or the minimum price of the IPO and the cap price or the maximum price. The investors must choose a price within this range called the price band. The most popular price among the investors is called the cut-off price. Shares are allotted to anyone who bids above the cut-off price in the requisite proportions depending on the size of the issue.

  • The success of an IPO depends heavily on market sentiments. The IPO investments are made for short term gains and investors invest in order to make profits mainly in a bullish market.

  • Investors in an IPO of a Company buy shares at a fixed price and do not have to pay stamp duty and brokerage fees.

  • About 50% of the IPO size is allotted to qualified institutional buyers. The IPO also has anchor investors who subscribe for 30% of the quota of the qualified institutional buyers. These anchor investors serve as brand marketers or ambassadors of the IPO. The investor sees names or institutions of high repute and this gives them a measure of confidence to invest in the IPO. They stay invested for a period of 30 days .If the qualified institutional buyers and anchor investors are bullish on the IPO then the price band is higher subject to a certain maximum limit.

  • According to the new rules every retail investor will get a minimum number of shares subject to availability while the remaining will be allotted in the requisite proportion. According to earlier rules in case of an over subscription the highest bidders were allocated shares and the bidders for lesser amounts got no shares. This discouraged lesser investors from participating in the IPO. This shortfall has been made up.

Frequently Asked Questions

Who regulates an IPO?

Security Exchange Board of India (SEBI) regulates an IPO process

What is a merchant bank?

When a company wants to raise funds through initial public offering (IPO) it appoints an investment bank for underwriting the issue. An Investment bank is also called as merchant bank.

What is the role of a merchant banker in IPO?

The primary role of a merchant banker should be to act as a bridge between the organization and the investors. Firstly, the merchant banker should have a brand image in the market. A merchant banker should have the capability and the experience to handle a large-scale IPO. And they should be able to reach a larger mass of people because investors today are just not located in the metros but also in tier-II and tier-III cities." Simultaneously, they also find out the risk management strategies for the company since risks and ventures are two sides of the same coin. Apart from being a link between the organization and the investors, a banker also has to generate interest and build up the confidence of the investors.

For how many days is the issue open?

Subscription list for public issues shall be kept open for at least 3 working days and not more than 10 working days.

Who decides the price of an issue?

The guidelines have been provided that the issuer in consultation with Merchant Banker shall decide the price. There is no price formula stipulated by SEBI. SEBI does not play any role in price fixation. The company and merchant banker are however required to give full disclosures of the parameters which they had considered while deciding the issue price.

Is it compulsory for me to have a Demat account?

As per the requirement, all the public issues of size in excess of Rs.10 crores are to be made compulsorily in the Demat account. Thus, if an investor chooses to apply for an issue that is being made in a compulsory Demat mode, he has to have a Demat account and has the responsibility to put the correct DP ID and Client ID details in the bid/application forms.

What is an IPO?

An Initial Public Offer (IPO) is a means of collecting money from the public by a company for the first time in the market to fund its projects. In return, the company gives the share to the investors in the company.

Can I apply for the IPO online?

As per the cyber rules of Government of India, this facility is not provided. Only in case of book building issues, the brokers can bid online on behalf of subscribers.

Having applied for an IPO how can I know my allotment status?

For a public issue, you can know the status by calling the registrar (you will know about the registrar on the Highlights Page of the issue) after 30 to 40 days from the closing date of the issue. However, in a book building issue, you can know the status by calling the registrar after 20 days from the closing date.

What is a draft prospectus?

A draft prospectus provides the information on the financials of the company, promoters, background, tentative issue price etc. It is filed by the Lead Managers with the Securities & Exchange Board of India (SEBI) to provide issue details.

When will the Share certificates / refund orders reach me?

 

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