When a company decides to go public — as in go from privately owned to publicly owned — it issues IPO for the public. IPOs or Initial Public Offerings is the process through which a private company offers a fixed number of shares to the public for them to purchase and invest in the company. Once the public buys the shares, the company is listed in the stock market; its shares are open to the stock exchange and trading.
For investors and traders who are newly venturing into the world of IPOs, you must have a good idea of what an IPO is and how it works. Here we will try and understand the concept of IPOs better by learning about the different types of IPOs.
IPO: Definition and How it works
To start with, we will draw a clearer picture of an IPO or Initial Public Offering. A private company may want to go public for various reasons, including the generation of a larger capital, improving public image, growth, expansion of the company, and so on. Whatever the reason, they need to follow a strict and regulated procedure called IPO to become public.
During IPO, the company specifies the number of shares issued to the public for them to buy for the first time. When the IPO shares are issued, the company is then listed in the stock market, and anyone with a Demat account can go for investment and trading.
But how does a company issue an IPO? First, the company appoints an underwriter on its behalf, which is essentially a group of investment banks. The underwriter is tasked with evaluating the company's financial standing, its financial requirements, the number of shares it can issue, and how much these shares will be priced at.
Once they have made these evaluations, they draft the IPO application and submit it to the SEBI. The SEBI then scrutinises the application and checks whether the company meets all the criteria a public company should have. Once the SEBI approves, the company is allowed to release a public prospectus, the Red Herring Prospectus. In this document, they announce their IPO and reveal details such as the number of shares to be issued, their price range, the company's past performance record, opportunities, risks, etc.
After a cool-off period, the IPO is opened, and the public is welcome to bid for their desired number of shares. After the bidding, their allotted number of shares is credited to them. Once the procedure is complete, the private company successfully transitions into a public company.
Types of IPO
IPOs primarily can be of two types — fixed price issues and book building issues. We will take a look at what these two types are and how knowing them can help you as an investor. Please note that before getting into IPO investments, you should clearly understand the types of IPO and know about IPO strategies and tips to have a healthy investment experience.
The types of IPOs are decided by how they are priced. Let us take a look:
Fixed Price Issue
When the IPO shares are issued with a fixed price, it is called a Fixed Price Issue. The company decides these prices along with the underwriters. These prices are allotted after carefully evaluating the company and its financial assets, liabilities, and other aspects. Investors are likely to be more interested in Fixed Price Issues as the prices are undervalued during the period of IPO, usually lower than the market price. As such, investors evaluate companies in a positive light.
Book Building Issue
On the other hand, the Book Building Issue is a concept recently introduced to the Indian subcontinent. It is a common practice around the world, however. The company states a price range or band instead of a fixed price in this issue. The lowest price is known as the ‘floor price’, whereas the highest price is termed as the ‘cap price’.
The way it works out is when the IPO is opened, you can bid for the number of shares at the price you are willing to pay. Once the company evaluates all the biddings, a price is then fixed for the shares. As the book builds, you will get to know the share demand progressively after each day.
When an IPO is opened, companies may go for Fixed Price Issues or Book Building Issues. At times, they may even choose to use a combination of both.
How are the two types of IPO different?
The two types of IPO will vary from each other based on the following factors:
Update on the Demand for Shares
In the Book Building Issue, you will get an update on how the demand for the share is after each day. For Fixed Price Issues, however, you will get to know about the demand for the shares only after the issuing of the shares closes.
Price of the Shares
The price for the shares in the Fixed Price Issues is fixed before the issuance of the shares begins. In Book Building Issue, the company and the underwriters set a price range where the investors can bid for the shares with the amount they would like to pay. Once the bidding closes, a fixed price is determined based on the evaluation of the biddings made.
Payment for the shares
The payment in case of a Book Building Issue can be part payment, as you pay a part of the amount during bidding and the rest after the allotment is done. You must pay the full share amount during the bidding for the Fixed Price Issues.
Different types of investors in IPO
While we are on this topic, we will also quickly examine the different types of investors in an IPO. During an IPO, there are different types of investors investing. All these different types may have reserve quotas to them or share percentages.
Qualified Institutional Investors (QII)
A large chunk of shares is reserved for these investors as they are very important investors for a company going public. Underwriters try to sell these shares to these investors at profitable prices. These investors comprise commercial banks, mutual fund houses, public financial institutes, foreign portfolio investors, etc.
When these investors buy a large chunk of shares, lesser shares are left for the general public to invest in, leading to higher share prices. However, as per SEBI guidelines, a company cannot keep more than 50% of the IPO shares reserved for these categories of investors.
Non-Institutional Investors (NII)
Companies keep around 15% of the shares reserved for this category of investors. These investors are willing to invest ₹2 lakh or more in the shares. This category of investors includes large companies and trusts, and so on. While QIIs need to register with the SEBI, the same is not required for NIIs.
Anchor Investors
The next type of investors are a kind of QII investors, but they can invest a minimum of ₹10 crores. Anchor investors can buy the 50% shares allotted to the QIIs. This type of investor is the newest addition (2009) to the lot by the SEBI.
Retail Investors
The value of the application for Retail Investors is less than 2 lakh. They are allotted a minimum of 35% of all the shares in an IPO. These types of investors are the most common type to apply for an IPO.
Conclusion
IPO is a major element in the stock market. The process allows a private company to become a public one. Even though IPO means the initial offering of shares made to the public, there are two types of IPO based on their prices. Fixed Price Issues are the shares whose prices are fixed. Book Building Issues are the shares that are released with a price range within which an investor can bid price for the shares.
Similar to IPO, different kinds of investors come into existence with the IPO. These are Qualified Institutional Investors, Non-Institutional Investors, Anchor Investors, and Retail Investors. If you are new to trading, understanding IPO is necessary, as well as learning how it is processed, the different types, and so on.
Frequently Asked Questions
What are IPOs?
IPOs or Initial Public Offerings are the first lot of shares that a private company offers the public for investment. Through an IPO, private company transitions to a public company.
How is an IPO issued?
The company will first appoint an underwriter on their behalf. They will draft the IPO application and submit it to the SEBI. Once SEBI approves the application, the company announces the IPO by releasing a prospectus. After that, the IPO is open for investors to bid for the desired number of shares.
How many types of IPO are there?
There are two types of IPO issues — Fixed price Issues and Book Building Issues.
What is a Fixed Price Issue?
A Fixed Price Issue is a type of IPO where the shares are issued with a fixed price. The company and its underwriter determine this price after a careful evaluation of the company.
What is a Book Building Issue?
A Book Building Issue is when the shares have a price range or band instead of a fixed price for the investors to buy. Based on the kind of bidding the company receives on its shares, a price is fixed once the biddings are over.
How is Book Building Issue better?
In the Book Building Issue, investors get a daily evaluation of the bidding process throughout the IPO. This helps them get a better understanding of the demand the IPO has.
How many types of investors are there?
There are four main types of investors — Qualified Institutional Investors, Non-Institutional Investors, Anchor Investors, and Retail Investors.