If you are a company looking for taking your company public or an investor wishing to invest in a IPO share, then you must read this blog before doing so.
In this blog we will learn the following:
What is an IPO?
In short, Initial public offering (IPO) is the process of allotment or issuance of shares of a private company to the public in a new stock issuance in exchange for funds.
Why companies go for an IPO?
Basically, the reason for a private company to go public is to raise funds. But there are many reasons too such as:
1. Firstly, a company may need funds to fund an existing or a new project. Hence, the funds used for such purposes is called CAPEX or capital expenditure. In fact, it is the most common reason for a company to go public.
2. Another reason for a company to go public is to pay existing debts. Sometimes there are situations when debts reach a level, where servicing the debt becomes quite an expensive affair. Here, the only thing that will come to mind is to go public.
3. Thirdly, the reason is to provide an exit to early stages investors like angel investors and venture capitalists who have provided funds to the company in initial stages of growth.
4. Finally, one last reason is to increase the visibility of the company, visibility increases when people trade your company’s stock and this will have a positive impact on growth.
Below are the steps of the IPO Process:
- Hire an investment bank:
Firstly, the company which is going public hires an investment bank also called merchant bank. However, all the major banks such as SBI, HDFC, Axis bank, etc have their investment bank arm which carries out mergers and acquisitions and brings IPO of private companies.
A company hiring an investment bank will look at its:
1. Reputation and track record in raising funds from IPO
2. Quality of research: how do they price the stock and carries out the evaluation of a company
3. Distribution of expertise: how many tie-ups they have with institutions and how good they can market retail and non-institutional investors.
- Due diligence and filings:
After the company has hired an investment bank, now the bank will do all the due diligence and legal processes.
2.1 – Underwriting
It is the most important step. It includes the following
1. Firm Commitment: Here the bank assures that if they are helping to raise 1000 crore, and if the money raised is less than they will put the balance money from their pocket. Also, if they raised a greater amount, the extra money will be theirs.
2. Best efforts commitment: in this method, the bank will tell the issue price, will tell the valuation of the company, and also will do its distribution, but it is not their guarantee, as to how many subscriptions they will be able to get.
3. Syndicate underwriting: if the amount to be raised is very big, then the bank will hire other banks and will allocate them some portion of the amount, ex. Tells bank A to raise 1000 crores etc. The main book manager or hiring bank is called the lead manager and the rest all are participating managers.
2.2 Red herring prospectus
In this part all the information about the company is written:
1. Business and promoter details
2. Competitive advantage
3. Capital structure
4. Future business plans
5. Risks and opportunities
6. Past financial data
2.3 Compliances and filings
In this part, all the regulations of SEBI, NSE/BSE, Companies Act, securities contract act comply.
1. Here the bank takes out the valuation of the company. let’s say there is a company whose valuation came out to be 10,000 Cr and the company decides to dilute its 20% share. The rest all will be with promoters and existing investors.
2. Issue Size: 20% of 10,000 Cr. is 2,000 Cr which is issue size.
Now, they will find the issue price i.e. the price at which share will be issued in IPO. Ex. Rs. 200/share.
Next, they will find the number of shares to e issued. Ex. 10Cr.
3. Lot size: here the bank issues a lot size. Ex. If the lot size is 50 then the investor can only book in the multiples of 50, shares to buy.
4. Minimum investment: Ex. Rs. 10,000.
There are two types of price issues that mean there are two ways in which a bank can decide to offer issue price.
1. Fixed price issue
Here, the banks will give a fixed issue price for bidding. But, it is not used mostly as there might be an error in calculating the valuation of a company.
2. Book building issue
Here the bank will issue price in the form of band ex. Rs. 180-200 for bidding. After all the bidding, any price can be taken final in between the band. Here, 180 (above ex.) is called floor price, and 200 is called cap price.
The maximum difference between the floor and the cap price can be only 20%.
Now, both the company and bank will market their stock for subscription and try to sell them to all the market participants.
- Application process
Now, the interested investors will fill the application for subscription. The bidding process is opened for 3-5 days.
- Share allotment
Now, the investors will gets share allotted based on their quota as QIB’s (qualified institutional buyers) have 50%, retail investors have 35%, non-institutional investors have 15% quota.
- Listing on stock exchange
Now, after share allotment, the company will get listed on the stock exchange (NSE/BSE). Listing is done in 3 days after the closing of the application.
IPO Share Allotment Processs
Before understanding the allotment process, you must know the categories of investors in IPO, these are:
1. Retail individual investors (RII)
These are the investors that invests less than 2 lakhs in an IPO.
2. Non-Institutional Investors (NII)
These investors or corporate invest more than 2 lakhs in an IPO.
3. Qualified institutional buyers (QIB)
Below, this category comes:
Banks, Mutual funds, Foreign institutional investors, Insurance funds, Pension funds, Provident funds, Venture capital firms
4. Reserved category
Under it comes employees and existing shareholders of the company which are going public. The employee of the company can buy shares of a maximum of Rs. 5lakhs.
When a bank goes to QIB’s, they ask them they can give them preferential treatment, if they agree to become anchor investors. However, for QIBs to become an anchor investor minimum bid amount is 10Cr.
The maximum 60% of the QIB quota of share allotment goes to anchor investor. However, from this 60%, 20% is reserved for domestic mutual funds, and 40% for the QIBs that are anchor investors. Finally, the remaining 40% is for the remaining QIBs that are not anchor investors.
Further, we would talk about the which we have talked about above.
IPO allotment of shares by book building issue
|Issue Size||2,250Cr – 2,500Cr|
|No of shares to be issued||10Cr|
|Minimum investment||Rs.11,250 – Rs.12,500|
(Here Tick size means investor can bid for the stock at Rs. 225, 230, 235, 240…..)
If you bid at a price that is less than the final price decided by the company, then you might not be allotted shares, if it is very much oversubscribed. However, your allotment chances increase if you bid closer to cap price.
If you bid at Rs.245 for example and the final price is Rs.240, then you will be allotted shares at Rs.240.
Finally, the final price is decided by the company on the basis of bidding. They will start from the cap price to floor price, till the prices at which all their shares are sold is decided as the final price.
Besides, I will tell you how the shares are allotted in different scenarios:
- If the subscription is less than 90%, there will be no allotment and the IPO will become scrap.
- Subscription is 90-100%, full allotment to all investors.
- Slightly oversubscribed (eg.1.5X): in this case
- The retail investors will get 1 lot, and the balance will be distributed proportionately to them.
- QIBs and NII will get in proportionate.
- Oversubscribed multiple times (100X): in this case:
- Retail investors will get 1 lot by computerized lucky draw.
- QIBs and NII will get proportional allotment
(Here proportionate means if a QIB applied for 15 lots then it will get 15/1.5 = 10 lots as it is oversubscribed 1.5X times)
After reading this blog, I am sure that you must have understand all about IPO – process, share allotment process.
If you want to learn more about the share market you can read my blog on Basics on Share Market.
Ans. No, you cannot apply without a Demat account. The shares allotted only come in your Demat account.
It is very easy to apply for a Demat account, you can apply for a Demat account at any stockbroker, I would recommend you to go with discount brokers such as Zerodha, upstox. You only need basic documents like PAN card, aadhaar card, etc.
Ans. Yes, you can apply through Zerodha. For applying for IPO you need to login to console. Then, select IPO in the portfolio menu. Select the IPO you want to apply for from the list.
I am a student currently pursuing B-tech in electrical engineering from Delhi Technological university.