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How Does an IPO Work for Investors in India

Initial Public Offerings (IPOs) can be rewarding investments. As an investor, you definitely don't want to miss out on these opportunities that don't present themselves all too often. Here’s what you need to know about IPOs before investing.

Key Points

  1. An IPO or an Initial Public offering, is an offer of new shares of a private company to the public for the first time. Ownership changes hands - from being entirely privately held, the company is now giving ownership to the masses.
  2. Not every company can afford to raise enough money from private investors. Also, going public presents other benefits than just raising capital.
  3. As an investor, you stand to make extremely high returns on your investment if you pick the right IPOs.

IPO definition

An IPO or an Initial Public offering, is an offer of new shares of a private company to the public for the first time. Ownership changes hands - from being entirely privately held, the company is now giving ownership to the masses.

Let’s get the basics out of the away first:

But, why do companies feel the need to raise money through IPOs? Of course, behemoths such as IKEA, Flipkart, Dell etc are still privately held by a few investors (in fact, Dell went back to being privately held after an IPO).

Though this might be the case with some companies, not every company can afford to raise enough money from private investors. Also, going public presents other benefits than just raising capital. Here are the reasons why companies go public.

The need for IPO

Did You Know?
Not all IPOs are a success. In 2012 - Samvardhana Motherson’s IPO had a disappointing start - with only 23% of its shares being subscribed.

As stated earlier, SEBI is the regulating authority here. It checks if criteria and norms laid down are met by companies before their proposed IPOs can be opened for public investment. What are these criteria and norms that companies have to fulfill? Let's take a look.

Criteria for filing IPOs

The following are the eligibility norms for companies planning to file an IPO as stipulated by SEBI.

  1. The company should have had net tangible assets (defined as physical assets plus monetary assets of at least 3 crore rupees in each of the last three years. Doesn’t include virtual assets with fluctuating value like shares)
  2. The company should have had an operating profit of minimum 15 crores for at least three years in the preceding five years.
  3. The size of the IPO can't exceed the company's worth by more than five times.

Even if these criteria are not fulfilled, the company can still file a request for approval of an IPO with SEBI. But, for such approvals, the IPO can only take the book buildingroute where 75% of the stock has to be sold to Qualified Institutional investors (QII). This has to be done for the sale of stocks under the IPO to be held as valid. Otherwise, the IPO is cancelled and the capital raised has to be returned.

SEBI functions to protect the interests of investors while ensuring that norms aren't too stringent to dissuade prospective companies that have the potential and the vision to deliver growth.

Initial Public Offering (IPO) Process Overview

Definitions
Book Building Route: It is a type of process that an underwriter uses to figure out at what price should an IPO be sold. Fund managers submit the number of shares they wish to purchase and at what price. This helps the underwriters determine the value & initial share price of the IPO.

Underwriter: An underwriter is the one (or a group of investment banks) who assesses a company’s financial needs and decides the price/price range of shares, number of shares etc. They also participate in the drafting of an IPO’s application to SEBI.

Finally, after the IPO comes to an end, the new public stock is listed on a stock exchange. From then on, trade can take place in the publicly held shares on the stock market. As an investor, you stand to make extremely high returns on your investment if you pick the right IPOs. It’s similar to spotting talent for a sports coach - with the right find, you stand to witness history being made!

Wrapping Up

  • Companies file IPOs to raise capital.
  • SEBI is the regulating authority which approves IPOs.
  • Once the IPO opens, bidding on shares takes place.
  • Shares are allotted once IPO comes to a close.
  • Trade on the allotted shares takes place in the stock market.