When a private company wants to raise more funds for itself, it does so through various options. It can approach its angel investors or those who have a core stakeholding in their company. It can approach private investors or a bank. However, almost all of these options can cost them interest and higher repayments, which may be counter-productive. Another option unlike these is an Initial Public Offering or an IPO.
What is an IPO?
An IPO is an open call to the public by a company that wants to raise additional capital. Private companies decide to make their shares available for sale to individual (or retail) investors, high-net-worth individuals, or other institutional investors. They release a tentative date for the IPO’s release where their shares get listed on stock exchange platforms – primarily the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE). They also release the tentative price per share which is generally kept low to appeal to investors. Investors get as many shares as they like and become shareholders with the sole intention of earning profits in the long run, while the company gets the capital it was looking for. So, an IPO becomes an equity investment opportunity for a potential investor and a means of getting financial support and more for a company.
What are the types of IPOs?
There are two types of IPOs – Fixed price IPO and Book building IPO. A fixed price IPO is when the company itself sets the price of each share, and the public has no option but to take it or leave it. The company doesn’t leave it to the demand and supply forces and takes matters into its own hands. A book building IPO is like a bidding war. First, the company initiates a price band (around 20%) lower than the share’s original value. Then, investors bid on the shares where they have to state the number of shares they want to buy and the price they are willing to pay for them. The final price of the share gets determined by the demand and supply forces and the investor’s bids.
What is the process of issuing an IPO?
Before a company issues an IPO, there are various steps it has to take. They have to first get underwriting for their shares. They then have to compile a document called a Draft Red Herring Prospectus or DRHP. This prospectus consists of all relevant information of the company’s underlying fundamentals, management and shareholder history, financial performance, profits, losses, and revenue, strengths and risks, industry trends, and other such necessary details. The DRHP aims to give investors complete insight into the company and its aims for the future. So, investors can make a well-informed decision. Moreover, the company has to follow all the norms set by the Securities and Exchange Board of India or SEBI. This is so that the company gets a stamp of approval and establishes its credibility among the public.
What is the process of investing in an IPO?
For the investor, the process looks different. The investor has to consider whether it wants to invest in the company. They have to read the DRHP in detail and read up on reports and analyses from unbiased third parties. The investor finds out whether the company’s goals align with their investment goals and horizon. Once an investor has decided to invest in the company, they have to decide the number of shares that they would like to invest in and arrange for the funds. To apply for an IPO, an investor also needs a Demat cum trading account to store all the shares and securities safely. Further, the account needs to be linked to their bank account. The investor also has to activate the Application Supported by Blocked Account (ASBA) facility to transfer funds smoothly. After the bidding starts, investors are given an allotment of shares from the company issuing the IPO. If the shares are confirmed, investors get a confirmatory allotment note, and then the shares get credited to the Demat account.
The bottom line:
To know if you are eligible for investing in an IPO, you must be an adult, have a valid PAN card, an active Demat account, and the necessary funds. Buying an IPO due to herd mentality, buzz, or popular sentiment is never a wise choice. That is why you must also read and understand the DRHP in its entirety and do your own research to know what company you will be backing. Ultimately, IPOs are usually a profitable equity investment that can give you high returns, provided you stay committed for the long term.