In this article, you will learn what an initial public offering is, the complete IPO process, such as approaching a merchant bank, DRHP, the specifics of an IPO, and things to know before applying for an IPO, such as the grey market premium and how to increase your chances of obtaining an IPO.
What is IPO (Initial Public Offer)?
An initial public offering (IPO) is the procedure by which a private firm first sells stock to the general public. In essence, an IPO indicates that a company’s ownership is changing from private to public. As a result, the act of initiating an initial public offering is also referred to as “going public.”
Startups and established businesses might choose to go public via an initial public offering (IPO). There are a number of reasons why a company may launch an initial public offering (IPO): to generate funds to pay off debts, support expansion plans, or to allow corporate insiders to diversify their holdings and create liquidity by selling all or part of their privately held shares as part of the IPO.
In simple words, when a company sell its shares first time it is called the IPO and this is the only opportunity for the investors to buy shares directly from the company. Otherwise after this retail investors have to buy from another shareholder.
Generally, only well-performing or well-established businesses attempt to raise capital via an initial public offering. Because every business requires a minimum of 90% subscription.
Let’s understand this with an example. If a company wishes to raise Rs 1000 crores via an initial public offering, If the share price is fixed at 1000 Rs., A total of 100 lakh shares will be issued. Therefore, at least 90 lakh shares, or 900 crores, must be subscribed to by the public. Then, and only then, will they be listed on exchanges such as the NSE and the BSE.
Who can apply for IPO?
Anyone who is resident of India can apply for IPO. This is a one time opportunity to buy shares directly from the company. There are different categories for the application with reserved quota. Basically there are 4 types of investors with their reserved quota, QIB, HNI, Retail and Employees of the company offering IPO.
Reserved categories for IPO Application
Qualified Institutional Buyers (QIBs)
The QIBs have the ability to invest in securities, such as stocks and bonds. They are a type of institutional investors who can purchase large amounts of securities. In QIB category who invest more then 10 crores are known as Anchor investors. There is a lock in period of 30 days for the anchor investors. Anchor investors are offered a day before the issue open for everyone. Public financial institutions, commercial banks, mutual funds and Foreign Portfolio Investors etc falls under QIB category
High Net-worth Individuals (HNIs or NII)
HNI’s or High Net-worth Individuals are a group of individuals with a high spending power. Some times HNI are also known as NII (Non institutional Investors). In an IPO application people who are willing to invest more then 2 lakhs are known as HNI. SEBI has instructed to reserve at least 15% for the HNI category.
You must bid for at least 2 lakh rupees of equity shares in an IPO to qualify as a high net worth investor (HNI). You may only bid for the HNI IPO application through ASBA utilizing the Net banking facility or by submitting the paper IPO application form. HNIs are not eligible to apply using the UPI-based IPO application process.
HNI Allotment is on a proportionate basis or lottery system in case of oversubscription.
Retail Investors
Investors who are willing to invest less then 2 lakhs in the IPO of a company are falls under the retail investors category. These are also known as RII. SEBI has instructed to keep at least 30% portion for retail investors in the IPO.
Employees
Some companies provide discounted price with reserved for their existing employees. In this category only the employees of the IPO offering company can apply under this category.
Below table will help you to understand the different type of applicants who can apply IPO.
| QIB | HNI | Retail | |
| Eligibility | SEBI Registered Institution | More than 2 Lacs | Investment less than 2 Lacs |
| Shares Reserved | 50% | Minimum 15% | Minimum 30% |
| Allotment Criteria | – | First Proportionate then Lottery | Lottery |
| Cut off price | – | Exact price | Can invest at cut off price |
| Bid adjustment | – | No | Yes |
| Apply through | Direct | ASBA only | UPI and ASBA |
IPO Application procedure
Applying
Before you apply you must have a demat account. Demat account is like a bank account which hold all your shares and other securities etc. To open a demat account you need to find a stockbroker. Check the list of share brokers registered under SEBI to open a new demat account.
The Indian government has taken a few steps in order to make it easier for retail investors to invest in IPOs. The recent changes in the IPO application process are aimed at making it easier for retail investors to apply for IPO. retail investors can apply for IPO through ASBA (Application Supported by Blocked Amount) and UPI (Unified Payment Interface).
ASBA is a facility which allows investors to apply IPO through net banking. UPI facility is available with the broker / trading account only.
In both the cases ASBA (Net banking) or UPI blocks the payment until the allotment. If shares shares get allotted payment will be transferred to the company other it will be released to use.
Below table show you the different type of application procedure for IPO.
| ASBA IPO Application (Net Banking) | UPI IPO Application | |
| Who can apply | Both HNI and Retail investors | Only Retail investors |
| Offered by | Banks only | Banks and Brokers |
| Time | Quick | Some times UPI mandate takes some time. |
| Complexity | Easy | Very Easy |
Bidding
An investor must submit a bid when applying for shares in an initial public offering. It is done in accordance with the lot size specified in the prospectus of the firm. The term “lot size” refers to the minimum number of shares that an investor must apply for in an initial public offering.
A price range is established, and investors are required to bid within that range. While an investor may revise his bids during an IPO, it is important to keep in mind that he must reserve the necessary cash while bidding. Meanwhile, the held funds generate interest in the banks until the allocation procedure will begin.
Allotment
Often, demand for the shares exceeds the amount of equity released on the secondary market. Additionally, one may encounter instances in which he receives fewer shares than he requested. In these instances, banks either completely or partially release the held payment. Following allotment, the shares are credited to the investor’s demat account.
After successfully completing the aforementioned processes, the investor must wait for the stocks to be listed on the stock market. It is usually completed within seven days of the shares being finalized.
Understand the process of IPO
There are two types of IPOs
1. Fixed-price offer
The term “fixed price IPO” refers to the price established by some firms for the initial selling of their shares. Investors learn the price of the shares at which a firm decides to go public.
Once the offering is concluded, the market demand for the stocks may be determined. If investors participate in this initial public offering, they must guarantee that they pay the whole amount of the shares when applying.
2. Book Building Offer
In the case of book building, the firm launching an initial public offering (IPO) provides investors with a 20% price band on the stocks. Before the ultimate price is determined, interested investors bid on the shares. Here, investors must select the quantity of shares they wish to purchase and the price per share they are willing to pay.
The term “floor price” refers to the lowest share price, while “cap price” refers to the maximum share price. Investors’ bids ultimately decide the price of the shares.
Role of Merchant Bank in IPO
Any company that wants to begin the IPO process to go public must contact a merchant bank. Merchant banks are not exclusively for IPOs. Additionally, they offer marketing and financial services. The company approaches a merchant bank with complete information about the company.
DRHP is an abbreviation for Draft Red Hearing Prospectus. The DRHP is essential to the IPO process. The DRHP includes a lot of information about the company, like its history, loans, revenue, and where it does business. It also explains why the company is raising money through an IPO, how the money will be spent, and what risks the company might face.
Following the conclusion of the DRHP, They submit it to the SEBI (Security Exchange Board of India). SEBI examines the DRHP and verifies whether the information provided is accurate. SEBI will approve if the DRHP is accurate and complies with all SEBI regulations.
The majority of initial public offerings are Book-Build Issues. For instance, the company’s price band for the first public offering is 175 to 180 rupees. Here, 175 Rs. represents the floor price and 185 Rs represents the ceiling price. Following the completion of the initial public offering process, the company will list on the NSE and BSE. The Public Can Now Purchase And Sell The Company’s Shares Via Exchanges.
Applicants who request a higher price will be given priority.
Basic terms used in IPO
Lot Size
Lot size indicates that we must apply in multiples of lots for an initial public offering. To apply for an initial public offering, for example, you must purchase at least 100 shares. If you want more shares, you must apply in multiples of lots, such as 200 shares or 300 shares.
Issuer
The term “issuer” refers to a corporation or business that wants to sell shares in the secondary market in order to finance its activities.
Underwriter
A banker, financial institution, merchant banker, or broker may act as an underwriter. It aids the corporation in underwriting its securities. Additionally, the underwriters pledge to subscribe to the balance shares in the event that the initial public offering’s equities do not attract sufficient investor interest.
How to increase your chances of obtaining an IPO
- Most importantly, a common error made by retailers is applying through many brokers of the same person, such as Zerodha, UPSTOX, or Angel Broking.
- However, it will be treated as a single application due to the fact that our PAN will be the same for all brokers.
- It’s similar to a lottery; the more applications from various accounts, the greater the chance of allocation.
- If You Want The Initial Public Offering, Then Apply For A Higher Price. For example, if the price band is between 105 and 110 rupees, apply for 110 rupees. Because applicants who request a higher price are given priority.
What is Gray Market or GMP
GMP means Gray Market Price. Actually, gray market is a term that refers to the stock trading that occurs outside of the formal exchange, such as on the street.
Lets understand this with an example. suppose a new popular film starring a major hero is released, There Wwill be a massive buzz around that film, and you want to see it on the first day of its release. However, obtaining tickets on the first day is extremely difficult.
In this case to get extra money, some members outside the theatre may sell tickets at a premium price. And if there are lots of people interested in purchasing tickets. Then he will give the tickets to whoever gives him the highest money. Typically, we refer to it as the black market.
Similarly, the grey market functions in the same way.
Many investors ready to pay extra premium to buy the shares who got the IPO. For example, if the share price is 1000 Rs, if the GMP is 200, it means they are willing to pay 1200 Rs per share in the grey market. A higher GMP indicates a greater interest in IPOs, Which generally means that IPOs will list at a higher price.
However, grey markets can be manipulated occasionally because if the gmp is increased, then the majority of retailers will apply for that IPO. People who were big or the company would sometimes manipulate prices in the grey market.
The grey market isn’t official. If something goes wrong, there isn’t anyone to complain to because it isn’t legalize. The grey market is managed by large brokers or operators and is also limited to certain cities. In the grey market, operators act as connectors between buyers and sellers. It is not official. Everything is based on trust.
Things to Consider Before Investing in an IPO
Investigate the company’s background.
Because the firm is preparing for its IPO, there may be little or no historical data on which to base your investment choice. The firm issuing it, however, does give a prospectus. People who want to invest in a company should carefully read and study all of the information that the company gives out.
Investigate the Underwriters
The success of the IPO is dependent on the large broker who is sponsoring the new issue. Investments in such offerings may be worthwhile if the underwriters are well-known.
Lock-in Period
Prior to applying for an IPO, you should review the contractual obligations of the company’s management and investors regarding their shareholding’s lock-in term. As soon as the lock-in period expires, the shareholders of the firm tend to sell their shares in the open market, resulting in a significant decline in share prices.
In the end
Investing in an initial public offering (IPO) is investing in the company’s future. The long-term returns on your shares will be determined by the company’s success and performance.
The stock market has a tendency to fluctuate. Investing in IPOs has the potential to yield incredible rewards, but it may also cause significant losses, so exercise caution.
