All You Need to Know About Initial Public Offerings (IPOs)

With so many Indian startups turning unicorns lately, with some taking the step to go public through their initial public offering (IPO), you might wonder what an IPO is and how it works. This article explains why companies launch their IPO and how investors can benefit from investing in one. 

What is an IPO?

The process of a privately held company going public by offering its shares to the commoners for the first time is an IPO. Through an IPO, an investor would get the company shares in exchange for an amount. Generally, companies go public through the IPO route to raise capital for their growth and expansion. Hence, IPOs are regarded as an efficient tool for companies to widen their businesses and an opportunity for retail investors to grow their wealth over time.

However, not every IPO is exciting, as not all of them could be a great opportunity. You need to assess the company’s fundamentals and growth potential before subscribing to an IPO. After the IPO, the stakes held by private owners of the company would be diluted, so would their influence and voting rights. 

What are the financial requirements for a company to launch an IPO?

The following are the most important requirements for a company to go public through IPO:

• Should have net tangible assets of a minimum of Rs 3 crore in each of the previous three years, out of which up to 50% can be held in monetary assets.
• Should have recorded an average pre-tax operating profit of at least Rs 15 crore in three of the immediate five preceding years.
• Should have a net worth of more than Rs 1 crore in each of the previous three years.
• If the company’s name was changed, then a minimum of 50% of the revenues generated in the previous year should be attributable to the change in the name.
• The issue shall not be more than five times the pre-issue net worth.

What are the types of IPO?

• Fixed Price Offering: This kind of IPO is when the issuing company sets its issue price for the initial sale of its shares. The issuing price would be made available to the public once the issuing company fixes it. We can gauge the demand for a stock post the initial subscription is closed. If you participate in the IPO, then you should make sure that you make the full payment for the shares when applying.
• Book building: In book building IPOs, the issuing company offers a 20% price band on the stocks for investors. Those interested would place bids on the shares before the final price is fixed. In a book building IPO, the investors must specify the number of shares they wish to buy. They are also needed to input the amount of money they are willing to pay for a share. Here, the lowest share price is called the floor price, while the highest price is the cap price. The investors’ bids would determine the price of shares.

What happens in an IPO?

Filing an IPO is considered a milestone in business. It requires companies to work towards getting regulatory approval relentlessly. If you think starting a company is difficult, then getting its IPO approved is a notch above. In India, the companies intending to go public are supposed to follow the stringent guidelines laid down by the Securities and Exchange Board of India (SEBI). 

A company will undergo stringent scrutiny by the market watchdog before being determined if it is eligible to file for an IPO. The following are the major steps involved in this process:

• The company should file for an IPO with SEBI by submitting all the required documents and information, consisting of the number of shares being issued, the set price, track record of the company, and the plans to utilise the capital being raised through IPO.
• Once the company receives the regulatory nod, it issues a red herring prospect, containing all the information regarding the IPO and its records.
• The company approaches a broking firm or investment banker to manage its IPO. This entity is referred to as the lead manager.
• The lead manager would then invite bids for the IPO from various investors. Here, investors can be both financial investors or retail investors.
• When the IPO is LIVE, the general public can subscribe to it and receive its shares corresponding to their investment.

Generally, the IPO of a company would be open for subscription for three days to 21 days.

What happens post IPO?

Once the shares have been issued to the buyers, the company gets listed on a recognised stock exchange. The company’s shares will then be available for regular trading as per the norms of SEBI. Depending on the success of the IPO, the share price of the company may list at a higher or lower than the IPO price. 

If a considerable number of investors who bought shares through the IPO sell their shares on a listing day, then the company’s share price may fall. The amount of shares in circulation is referred to as float. The company will then have to make disclosures and undergo audits at regular intervals in accordance with the SEBI norms. 

How to invest in an IPO?

You may invest in an IPO if you satisfy the following requirements:

• You hold a PAN card issued by the income tax department.
• You hold a Demat account with a depository participant.
• You may or may not have a trading account. However, you may require a trading account to sell the shares you purchased through the IPO.

As an investor, you have a chance to make considerable listing gains. However, you also risk suffering if the IPO fails to list at a premium compared to the issue price. 

For any clarifications/feedback on the topic, don’t hesitate to get in touch with the writer at vineeth.nc@cleartax.in