Whether you are a stock investor or not, you might have heard the phrase ‘a company went public’ either online or in a newspaper advertisement. What does going public mean? In the simplest terms, ‘going public’ is the process of a private company raising capital by issuing shares for the first time.
In a private company, the number of shareholders is limited by law. However, it has the option of raising capital from people by making them shareholders in the company and converting into a public limited company. When a private company approaches people to invest in exchange for a shareholding in the company, it launches the first offer called an IPO or Initial Public Offering. Today, we are going to discuss IPOs and also look at how to invest in an IPO.
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What is an IPO?
As explained above, once a company decides to go public, it launches an Initial Public Offering or IPO. The Securities and Exchanges Board of India (SEBI) regulates the launch and ensures that the IPO is in sync with the integrity of the markets and the interests of investors. After the company completes the required paperwork, the IPO is launched.
The stock market can be divided into two segments:
The company launches an IPO in the primary market. This is the place where an investor can purchase shares directly from the company. Once the shares are allotted, the company’s name is listed on the stock exchange. Here, investors can trade shares.
IPO’s can be classified into the following types based on the kind of offering made by the company:
- New Offer – A new offer is an IPO launched by the company for the first time
- Follow-on Offer – If the company has already issued shares in the past but wants to raise more funds by selling additional shares, it launches a follow-on offer.
Sometimes, the promoters or major shareholders in the company sell a portion of their shareholding via an IPO. This is known as an Offer for Sale or OFS.
Here is an interesting question. In the stock market, the price of a share is determined by its demand and supply. How is the price of a share determined in an IPO?
In an IPO, a company determines the price of a share in two ways:
1. Fixed Price
In this method, the company fixes the price of the share issued by it. Hence, investors know the exact price of the share before applying. Since the demand is known only after the IPO is launched, the company determines this price based on the funds that it wants to raise.
2. Book Building
In this method, the company launches an IPO with a price band. The lowest price in the band is known as the floor price and the highest price is called the cap price.
There is no fixed price. Instead, the company discovers the price during the course of the IPO. Investors are asked to bid on the shares by specifying the number of shares they want to buy and the price that they are willing to pay for each share. Once the issue is closed, the company assesses the demand at each price level and determines the final issue price.
Before you look at how to invest in IPO shares, it is important to understand IPOs and the option available to you. With this basic information clear, let’s look at the process of investing in an IPO online.
What is the Process of Investing in an IPO Online?
Investing in an IPO is a great way to buy shares as it allows you to invest in a company before the demand and supply of the market affect its price. Here is the process:
1. Choose the IPO That you Want to Invest in
Before understanding how to buy an IPO, you must determine which IPO you want to invest in. In 2020, around 40-50 companies are expected to launch IPOs and raise funds in the range of Rs.40000-50000 crores. Hence, determining the IPO that you want to invest in is an essential first step.
Every company that launches an IPO, shares a prospectus with the public offering details about the company’s business and future plans. Go through this prospectus thoroughly and research the company before making a decision.
2. Open the Required Accounts
You need the following three accounts to invest in an IPO and trade them in the secondary market eventually:
- Demat Account – where the shares are stored in an electronic form. It is mandatory to have a Demat account to invest in an IPO.
- Bank Account – to make payment for the applied shares. This is done via the Application Supported by Blocked Amount (ASBA) facility (explained below).
- Trading Account – this is needed to invest in an IPO online. You can open this account with a brokerage firm or a company that offers stock trading facility.
3. Fund the Application
The process of buying shares in an IPO is different from that in the secondary market. Regardless of a fixed price or book building issue, usually, the number of shares allotted is lower than that applied for.
When a company launches an IPO, it fixes the price or the price band based on the funds that it wants to raise and the price at which it expects to sell all shares. However, in most IPOs, the demand for shares in the issue is much higher than the number of shares issued by the company. Also, since companies allot shares proportionally, investors tend to receive fewer shares than those applied for.
Let’s say that a company issues 1 lakh shares in its IPO but receives applications for 4 lakh shares. It manages this oversubscription by allotting 25% shares per application. So, if you have applied for 100 shares, you will be allotted 25 shares only.
Hence, if you expect the IPO to create a buzz and generate interest among investors leading to oversubscription, then it is prudent to apply for a higher number of shares.
However, when you submit the application, you need funds to back it up. Also, if the IPO is not oversubscribed, then you will have to purchase the number of shares applied for. Hence, you need the funds available in your banking account.
Understanding ASBA & UPI
Earlier, investors were required to send money to the company along with the IPO application form. Once the issue was closed and the allotments made, if the number of shares received was lesser than those applied for, the investor would receive a refund of the difference.
This took around 21 days to process. SEBI realized that the investor’s funds were unnecessarily blocked in this process and launched a new way of applying for shares in an IPO – ASBA.
The Application Supported by Blocked Amount or ASBA facility authorizes banks to block the IPO application amount in the investor’s bank account. This amount is not debited and the investor continues to receive interest on the blocked funds too.
Once the shares are allotted, the amount equal to the cost of the allotted shares is debited and the balance is released. To use the ASBA option, you need to submit the ASBA application form to your bank.
In 2019, SEBI introduced United Payments Interface or UPI as a mandatory payment method for IPO applications. Under this option, investors need to specify their UPI ID on the IPO application form and approve the ‘block funds’ mandate on the UPI app.
4. Follow the Application Process
The process of applying online for shares in an IPO is very simple:
- Login to your trading account and select the IPO that you want to invest in.
- Enter the price at which you want to apply for shares (in case of a book building issue) and the number of lots (explained below)
- Fill the application form completely and provide your UPI ID
- Approve the block funds request on the UPI app
Every company determines the minimum number of shares that investors can apply for in an IPO. For example, a company can define a lot size of 20. This means that investors can apply for at least one lot or 20 shares. If you want to apply for more, you can increase the number of lots.
How to Bid in an IPO?
Understanding the bidding process is important to ensure that you receive an allotment of shares in the IPO. If the IPO is using the book building method, then you will have to place a bid – choose the number of lots that you want to apply for and a price within the price band. Let’s understand this process with the help of an example:
ABC Private Limited launches an IPO with a price band of Rs.105-110 and a lot size of 10 shares. Let’s say that you want to invest in one lot only. You have the following options:
- Bid at the floor price – The total application amount would be Rs.1050 (floor price x number of shares per lot x number of lots = 105 x 10 x 1 = 1050)
- Bid at the cap price – The total application amount would be Rs.1100 (cap price x number of shares per lot x number of lots = 110 x 10 x 1 = 1100)
- Bid anywhere between 105 and 110 – Let’s say that you bid at Rs.107. The total application amount would be Rs.1070 (bid price x number of shares per lot x number of lots = 107 x 10 x 1 = 1070)
- Invest at the cut-off price – The cut-off price is the final issue price of the shares. If you choose this option, then you indicate your willingness to subscribe to shares at any price within the price band.
Let’s say that after the book-building process, the company reaches a cut-off price of Rs.109. Let’s look at what will happen in the four instances explained above:
- Floor price bid – You will not be eligible for any share allotment
- Cap Price bid – You will be eligible to receive allotment at Rs.109
- The selected bid price of Rs.107 – Since the bid price is less than the cut-off, you are not eligible to receive an allotment
- Cut-off price – You will be eligible to receive allotment at Rs.109
Hence, selecting the cut off option is usually recommended by most experts. Also, investors are allowed to make a maximum of three bids.
Allotment of Shares
Once the issue is closed, the company determines the cut-off price and allots shares. Based on your bid price, you might get fewer shares than applied for or none at all. Your bank account is debited for the exact amount of shares allotted to you.
Once the allotment process is done, you will receive a Confirmatory Allotment Note or CAN from the company and receive the shares in your Demat account. If the shares allotted are fewer than those applied for, then the extra amount blocked in your account is released.
Also, shares issued during an IPO are listed on the stock exchange within seven days from the date of finalization of the issue.
There are many things that you need to know before investing in an IPO. We hope that this article helped answer all your questions about how to purchase an IPO. Remember, while companies try to create a buzz in the markets just before launching an IPO, you need to ensure that you research the company thoroughly before investing. Also, understand the entire process well and fill the application form correctly to avoid rejection.