Many new investors in India have entered stock markets in this pandemic and must see many IPOS during the year 2020. They have been inclined to what it is and how it works.
This article explains what IPO, which means IPO, is from the perspective of a company. After reading this article, you will understand why a company decides to get listed on stock exchanges.
What is an IPO?
IPO stands for Initial Public Offering, in which shares of a company are offered to the public for investment and trading. In return, the company receives money from IPO underwriters. An investor must bid in lots (multiple shares) through their demat account and then the allocation process takes place.
A company goes public through the IPO in 2 situations. First, when he needs a huge amount of money for his growth. Second, to provide liquidity to its existing shareholders, who are the promoters and founders. Other reasons may be to gain credibility with the public, establish a net worth in the market, and gain greater exposure in the country.
Difference between IPO and shares
IPO is a mode through which a company’s shares get traded publicly among retail and institutional investors. Shares offer ownership rights to an investor. For instance: Let’s say that a company XYZ has 1 lakh outstanding shares in the market and one of its investors, Mr. P, holds 2,000 shares. This means that Mr. P holds a 2% (2,000/1,00,000) stake in the company. In other words, Mr. P has 2% ownership in XYZ.
How does a company apply for an IPO?
It starts with getting board approval to apply for an IPO, and then the company must select an investment bank or commercial bank to assist with the IPO. The investment bank helps the company with due diligence and all necessary regulatory filings with the exchanges. The investment bank also helps the company to write an application with all the financial details and goes to SEBI (Securities and Exchange Board of India), the market regulator. SEBI then allows the company to issue what is known as a DRHP (Draft Red Herring Prospectus) which contains full details of the number of shares outstanding, the price range and the company's past financial performance. This part of the prospectus and the valuation are also carried out by the investment bank itself. After that, the IPO will be issued for 35 days, during which investors can submit their bids to take over the company's shares.
How is the issue price calculated?
The issue price or the price band is arrived at after in-depth analysis by the underwriter or the investment banker. The factors considered are the amount of capital a company wants to raise and the number of shares going public, the demand for the company’s shares among investors, its financials and valuation, their market share in the industry and awareness among investors, and so on.
Where does the IPO money go?
The company going public gets a significant chunk of the money raised from the IPO and uses it to grow. They can invest it to fund new projects, R&D, working capital or for other purposes mentioned in the prospectus. The founders and promoters get money on selling their shares after the lockup period is over.
How long does an IPO last?
In India, the IPO usually lasts from 3 to 15 days depending on certain factors. First 3 days are reserved for bidding where several investors place their bids. This is followed by the process of rejection of invalid bids, post which allotment of shares takes place. Then, the allotted shares are credited to demat accounts of investors and the company receives the money. This is the entire IPO process in a nutshell.
Advantages and disadvantages of an IPO
Below are some advantages of an IPO:
- Amount size: A company can raise an enormous amount of money through an IPO by going public than what it can get via a loan or from its founders.
- Credibility and publicity: Once a company goes public, it tends to gain credibility in investors’ eyes as auditors and securities market regulators also monitor its actions.
- Stocks for payments: If the company’s shares are being traded publicly, it can use the stocks as a mode of payment to employees and board members in the form of a stock options plan.
There are also some demerits of going public:
- Cost of an IPO: Surely, an IPO brings a lot of money, but it has a cost attached to it in the form of fees paid to the investment bank, lawyer, consultant, and accountant.
- Additional disclosures: Now though the company is public, there are several regulatory norms to be followed. It will have to present its audited financial numbers every quarter to its investors.
- Under subscription: There are chances that investors might not react with enthusiasm in bidding for the company’s IPO. In that case, the IPO will be undersubscribed and the capital raised would be lesser than what it expected.