IPOs for Beginners

Introduction

IPO stands for Initial Public Offering. IPOs are great ways for private companies to generate more capital for themselves by selling off their shares. Conversely, it is also a great opportunity for those invested in the private company issuing IPOs to profit from the premium shareholder benefits that IPOs endow upon investors.

IPO can be viewed as a company restructuring move as it transforms from being a private company to being public. However, all that said, raising equity and capital remain the top reasons for a company opting to create IPOs in the first place. Let’s look in detail at what IPOs are and the stages in an IPO.

What is an IPO?

IPOs, or Initial Public Offerings, are a process rather than being a “thing” or a tangible item. IPO refers to the process a private company goes through when it goes public with its shares. By adopting the IPO process, a private company is able to raise capital from the public investors by offering its shares up for trade as new stock issuances in the Stock Exchange. When the IPO process is complete, these companies get listed in various market indices based on the performance of their stock.

However, IPOs can’t just be initiated left and right – there are certain rules, eligibilities and regulations that a company needs to fulfil before its IPO process can begin. Typically, these requirements are set by authorities like the Securities and Exchange Commission (SEC). Once eligibility is established, the IPO process can begin.

Let's look at various IPO stages now.

Stages in an IPO

There are basically three major stages in an IPO: the transformation stage, the transaction stage and the post-transaction stage, each with its own unique properties. Let’s see what they are.

The Pre-IPO Transformation Stage

This can be safely referred to as the most difficult of all IPO stages, owing primarily to three reasons:

1) The founding members’ view of transforming their brainchild venture into a public company through IPOs may be quite rigid and unchanging. However, the way it helps a company generate capital may sway their decisions in favour.

2) IPOs require a complete restructuring of the organizational setup, as essentially the company goes from being privately owned to a publicly shared entity by issuance of shares.

3) A redesign of policies and company frameworks is a colossal task that requires the hiring of capable minds who know how this overhaul needs to be handled.

Given the three factors above, the first stage of an IPO is the transformation, planning and overhaul stage. This is where the companies decide that they want to raise equity from the stock market.

The IPO Transaction Stage

The transaction stage in the IPO process is the step where a company does everything it takes to ensure that the shares it is planning to issue succeed in the market. Three distinct activities happen in the transaction stage:

1) The company hires or onboards professional analysts and financial specialists to evaluate it critically and publish their reports so as to garner investor confidence in the company’s shares.

2) The PR activities of the company increase in an attempt to create a hype that it is going public; it kind of works similar to marketing that helps get its shares traded in the market.

3) The company aggressively works towards setting goals and targets that enhance the value of its shares and works towards achieving these milestones to ensure the success of its IPO.

In short, the transaction stage involves activities that help ensure the success of a company’s IPO in the future; this stage takes place right before shares are issued.

The Post-IPO Transaction Stage

The post-IPO transaction stage has more to do with delivering on the promises and deliverables that the company promised itself and to the shareholders while issuing IPOs. It is important to note that the assessments and reports generated by analysts typically take a little longer to achieve; a company in the post-IPO stage gears up to ramp its operations up in order to achieve the promised numbers quickly and go beyond.

This is a stage where a company indirectly communicates to its investors and shareholders that it is a long-haul performer instead of a short sprinter. This is what decides the future of the company’s IPO including its current performance in the market.

Popular Terminologies around IPO

In 2021, investors seemed really interested in investing in IPOs. IPO or Initial Public Offering is when a private company offers its shares to public investors. Plan on participating in upcoming IPOs? Then it is essential to know what specific terms associated with IPO mean. In this article, we will discuss some frequently used IPO jargon.

Key Terms Related to IPO

ASBA

Earlier, investors had to pay the company at the time of application. If the number of shares allotted was less than the asked bid, the company would refund the money, which was time-consuming. SEBI drafted ASBA or Application Supported by Blocked Amount as a solution to safeguard the interests of investors. 

ASBA ensures that the money remains in a blocked state in the investor's account. After the shares are allocated, the designated amount is debited based on the number of shares, and the remaining money is unblocked. This makes the process of payment simpler and faster.  

Abridged Prospectus

Abridged Prospectus is the summary of the IPO prospectus, which contains all the salient features of the main prospectus. According to the Companies Act, 1961, the abridged version must accompany all IPO prospectus. So, if you are thinking about investing in IPO, this is the first document you need to look at.

Red Herring Prospectus 

DRHP is the draft prospectus filed by a company to SEBI at least 21 days before the IPO. SEBI reviews the prospectus in this duration and makes suggestions. RHP or Red Herring Prospectus is the final prospectus or the offer document, which the company files before the IPO. It contains all the information about the company and the IPO that investors need, like its objectives, management credentials, company's description, future strategy, operational data, price band, IPO calendar, etc. 

Price Band 

The price band is the price range within which you can bid for the company's shares. For example, if the price band is 500-550, you cannot bid below 500 or above 550. The company and the underwriter decide the price range for different investor classes like high-net-worth individuals, retail investors, and qualified institutional buyers.

Book Building Process

Investors bid for the company's shares according to the price band. Once the bidding process is over, the company analyses the bids and decides the issue price. If the investors show demand and bid high, then the issue price is closer to the higher end of the price band, and if they bid low, then the issue price is towards the lower bracket of the price band. This process is called book-building. 

Issue Price

The price at which the company allocates its shares to the investors is called the issue price. The issue price is different across the investor classes; it is the lowest for the retail investors.

Floor Price

The floor price is the minimum price an investor can bid on while applying for an IPO. For IPOs that follow the book building method, the floor price is the lower limit of the price band. 

Cut-off Price

The lowest issue price at which shares are allotted in an IPO is the cut-off price. It is usually reserved for retail investors. If you bid at a higher rate than the cut-off price while applying, the extra money is not debited from your account, as per ASBA.

Offer Date

The first date when investors can apply for shares in an IPO is called the offer date or the opening date of the IPO.

Listing Date

Once the IPO closes and the shares are allotted, the stakes are listed on the stock exchange. The date on which the IPO shares start trading on the stock exchange is the listing date. Therefore, it is crucial to ensure that the shares are transferred to the Demat accounts of all the investors who were allocated shares before the listing date to start trading them on the listing date itself.

Oversubscription

An IPO is said to be oversubscribed if the applicants bid for more shares than the company offers. This excess amount received by the company owing to an oversubscribed IPO is called oversubscription. 

Minimum Subscription

A minimum number of subscriptions is needed from retail investors for an IPO to go through. This minimum percentage is called a minimum subscription. The minimum subscription at present is 90%. If this threshold as prescribed by SEBI is not met, the entire subscription amount has to be refunded by the company. 

Underwriter

An investment bank works alongside the company to manage the operations of an IPO, like determining the offer price, marketing the IPO, and issuing the shares to investors. These investment banks are called underwriters. They charge an underwriting fee for their services.  

Bid Lot

The minimum number of shares an investor needs to bid for in an IPO is the Bid Lot. If the investor wants more shares, he will have to bid in multiples of the bid lot. For example, if the bid lot for an IPO is 1000, you can either bid for 1000 or multiples such as 2000, 3000, etc.

Conclusion

Applying for an IPO may seem a very daunting process, especially given the numerous formalities that have to be taken care of before applying. The very unfamiliar IPO lexicon further worsens this complication. This blog should serve as a comprehensive guide if you are starting on your IPO investment journey but are confused about the technical terms. Happy Investing!