Initial Public Offerings, or IPOs, have been on the rise these last few years with a lot of companies going through the process recently. These IPOs have created a huge buzz, and have made a lot of investors curious and willing to invest.  Though they are a fairly commonly seen term nowadays, there are a lot of industry terms that can confuse you, or worse yet, make you shy away from an excellent investment opportunity.

While it is important to know the market and which companies are launching their IPOs, it is also important to have a basic understanding of the terms that can help you navigate your way around these IPOs.

Let’s decode in layman’s terms the commonly used jargon, and hopefully make your IPO processes a little easier.

What is an IPO?

Short for Initial Public Offering, an IPO is the point where any existing company decides to invite the public to invest in them by buying their shares. The company, thereafter, gets listed on the stock exchange and is open for investment by the public, with its stock being publicly traded. Any company can only ever have one IPO, though a company may issue new shares after its IPO is completed. In case a company that is already listed on the stock exchange comes out with a new range of shares, it is known as a Further Public Offer.

Pricing and Book Building

The issue/offer price of a share is the price at which a share is distributed to the general public, before they are traded on the stock market and the price fluctuates according to market trends. The process of discovering the issuing price of the shares is known as price discovery and can be done using two methods.

The first, is called a Fixed Price Issue. In this method, the price of a share is fixed by the company (with the help of its Lead Manager) and applications for shares are invited at this fixed price.

The second method is something called book building, where bids are invited for shares, not at a fixed price, but within a range. The lower limit of this range is called the floor and the higher limit is called the cap. During the bid, you can ask for the number of shares you’d like to have and the price that you are willing to pay for them, within the price band. The actual price is then discovered based on the bids received.

What is an Allotment?

Allotment, in simple terms, can be defined as the process by which you are given shares upon your application. During the book building procedure, there are three kinds of investors who can make a bid for the shares.

The first category of investors are the Qualified Institutional Buyers (QIBs). These consist of mutual funds, and foreign institutional investors. The next is retail individual investors. Any investor that makes a bid under Rs. 50,000 can be labelled as a retail investor. The remaining shares are offered to individual investors with a high net worth (HNI) and the employees of the company.

Depending on how a company chooses to go about its price discovery, there are rules that govern what percentage of shares should be allotted to which investors. For example, if a company chooses a fixed price issue, a minimum of 50% of shares should be allotted to retail individual investors.

Once all applications are received and validated, shares are allotted to investors, with everyone who applied getting their allotments in an ideal scenario. When the number of shares applied for is greater than the actual number of shares available, the IPO is said to be oversubscribed. In these instances, shares are again allotted based on prescribed SEBI guidelines. One scenario worth discussing is if an IPO is oversubscribed to the extent that not everyone who applied during the IPO can even get one share. In these cases, final allotment is decided based on a lottery to ensure no preferential treatment.

What is a Draft Offer Document?

Any company aiming at issuing its IPO is required to file its prospectus with SEBI, which contains all the information about the company. This prospectus also tells you why the company is issuing shares for public investment purposes, along with information about the company’s financial position, and the issuing price of the shares.

The Draft Offer Document is first filed with SEBI, at a minimum of 21 days before filing it with the stock exchange. Prior to filing the Draft Offer Document with the Registrar of Companies (RoC), the document needs to be revised with all suggestions from SEBI.

What is a Red Herring Prospectus?

A Red Herring Prospectus is basically the same as a draft offer document and  contains the same information, without the addition of the number of shares being issued and the price per share. The reason for the prices being undisclosed is that a red herring prospectus is used exclusively for book-building purposes.

Who is an Underwriter?

An underwriter is the entity that picks up the remaining shares at the IPO in case all shares are not subscribed to. An underwriter to an IPO can be a merchant banker, a broker, or a financial institution that has given a commitment to underwrite the issue.

In case an underwriter fails to hold up their end of the commitment of picking up the remaining shares, their licences get cancelled by SEBI.

Who are Lead Managers?

Lead managers are the entities who are responsible for acting as the intermediaries between the company and the investors, with proper validated registration from SEBI. They are merchant bankers who are in charge of the entire issue process. It is a lead manager’s role to certify an issue in accordance with the regulations and carry out due diligence that everything mentioned in the prospectus is correct.

Furthermore, they are also accountable for the book-building process, in which case, they are referred to as the Booking Running Lead Managers. Activities that come after the issue, such as the intimation of the allotments and the refunds, are also taken care of by the lead managers.

There are never any guarantees that you will get an allotment on subscribing to an IPO. However, it always helps when you’re familiar with the terms being thrown around during the process and will hopefully help your next IPO application be a little easier to navigate.

As the name suggests, an IPO, or an Initial Public Offering, can be considered to be a company’s debut on the stock market as a publicly traded company, changing from being a privately held entity. The company that is issuing the IPO raises the capital in the primary market, and after the completion of the IPO, all investors can trade its shares, which is then referred to as the secondary market. 

While from the perspective of an investor, an IPO presents an opportunity to attain shares of a company that showcases the potential to grow, to the company, it is an opportunity to raise capital from the public market and use the funds for purposes that will help them achieve their ambitions of growth.

Why does a company launch an IPO?

While it may seem to be a simple process to bring a company into the public market, the process is long and involves a lot of steps that need to be completed. Starting from making the choice of an investment bank to ensuring the regulatory filings, there are several stages before a business can offer the shares of their company to the public.

This may raise a question about why companies should trade their companies publicly, and dilute their shares. To answer this question, it is important to understand the following advantages of going public.

Increased Capital: By publicly trading their company, a business has the opportunity to raise a higher capital than they could have been able to as a privately held company. The other methods of raising capital, in the form of loans, are riskier and more expensive than launching an IPO. Furthermore, a loan limits the capital raised, while an IPO allows the company to raise capital from the public market.

Publicity gain: Offering an IPO allows a company to gain publicity by being listed on the stock exchange. This results in the company becoming more recognisable to the public, increasing consumer trust in the brand, its products and services. This increase in publicity also facilitates smoother acquisitions and mergers along with higher cash flow due to the publicly listed shares.

Credibility Formation: A result of being a publicly listed company after an IPO causes the company to have an increased visibility, which also increases the credibility of the company.

Assessment of Valuation: After a company is listed in the stock exchange, the valuation of the organisation is bsaically equal to the amount that investors are willing to pay for it. This allows investors to know and understand the valuation of the company. A proper valuation assessment also makes it easier to carry out mergers and acquisitions when needed.

What kind of companies are launching IPOs?

In the current scenario, a lot of companies, including new-age consumer tech companies and startups are pursuing an IPO. The year 2021 proved to be a record year for IPOs, witnessing investments worth over Rs 1.3 lakh crore across 65 IPOs. This record amount was more than four times the entire amount that was raised in 2020 by IPOs, which amounted to Rs 26,628 crore.

With the Indian IPO ecosystem growing at a rapid pace, it is expected that 2022 will also bear witness to a very active IPO market. For you as an investor, it is expected to be one of the best seasons to take part in the IPO boom, and secure your future.

While investors will see increased chances of investing in the market, it should be noted that in 2021, a lot of companies experienced a downturn after launching their IPO, which has resulted in investors becoming much more cognisant of current market situations. Companies likely to have an IPO in 2022 include the likes of the highly anticipated LIC, along with companies like Pharmeasy, MobiKwik and Ixigo. 

In 2021, new age digital firms like Zomato and Nykaa succeeded in gaining the highest amounts in fresh capital. However, PayTM, which raised Rs.18,300 crores through their IPO, surpassing Coal India in the amount of capital raised, saw a decline in their share prices.

Should you invest in an IPO directly?

Many investors buy the shares of an IPO with the intent of associating themselves with a company and earning long term gains for themselves in the process. However, there are also investors who invest in IPOs with the specific purpose of listing short-term gains. Depending on the demand of a company’s shares, the listing price (the price that you actually see for a stock on the stock market) of a company can be either higher or lower than the offer price. If the demand for a company’s shares is high, the listing price becomes higher than the offer price, and you stand to make significant returns on your investment. However, according to financial experts, when it comes to well-managed companies, it is usually advisable to stay invested for the long term after investing in their IPO to give yourself the best chance of maximising your returns.

Many investors are not fulfilling their maximum potential gains by exiting their investments too quickly after listing. In such cases, a thematic fund, or an equity mutual fund serves you well because they hold investments for a longer time after listing. With the IPO frenzy currently going on, it is also possible that many investors do not get shares allotted to them in the IPO. In such cases, you can also choose to take the mutual fund route to an IPO. However, it is always best to consult your financial advisor before you make an investment decision.