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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.
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.
