Initial Public Offer

Initial public offer (IPO) as the name suggests refers to when a company goes public or issue shares of the company to the public in order to raise capital for the first time. After the IPO, the company gets listed and its shares are traded on stock exchange. Once it gets listed then the permission to trade these shares is granted by shareholders i. e. to whom the shares have been allotted in the IPO. There can be many reasons for bringing out an IPO. First, when the company issues new shares to the public, then the money raised from public goes to the company.

Second, when the Govt. Sell their stake in the company to the public, then the money raised goes to the Govt. (like the disinvestment of PSUs). However, one must be wondering why would individuals invest in a particular company? The answer is dividends. The shareholders expect the company will distribute the share of future profits among them as dividends. How an IPO is conducted IPOs generally involve book runners i. e. one or more investment banks known as underwriters. The underwriters retain a portion of the proceeds as their fee. This fee is called an underwriting spread.

Various methods of conducting an IPO are Dutch auction, Firm Commitment, Best Efforts, Bought Deal and Self Distribution of stock. IPOs can be made through the Fixed Price Method or Book Building Method. In the fixed price method, the price at which the securities are offered is fixed in advance. In the book building method, the investors have to bid for shares within a price band specified by the issuer and the final price is decided after observing the result of the bidding. The fixing of the band and the bidding process are done with the help of an investment bank or a group of several companies specializing in securities.

While most of the companies are eligible to make a public issue are free to decide the price band but infrastructure companies are subject to follow SEBI norms as well as banks are required to get RBI’s permission. The prices are decided by the company’s board of directors, which fixes the band after consulting the book runner (particularly an investment bank). In India, the issuer is allowed a price band of 20% (that is the cap of band should not be more than 20% above the floor price i. e. the lowest price that a seller will accept). After deciding the band, bids are invited on all prices of the band.

Once the book is closed, the seller fixes the price at which all of its shares will get sold. However, there can be a situation of Oversubscription of an IPO (i. e. if applications are received for more number of shares than the company is authorised to allot). In that case, the allocations would be done proportionately among all the successful bidders i. e. among those bidders who did bidding at the price determined by the company or at the price higher than that. After the price has been determined on the basis of bidding, the public advertisement containing the rice as well as table showing the number of securities and the amount payable by an investor is issued. Various Investors Involved ? ? ? Retail Investors Non-Institutional Investors Qualified Institutional Buyers If a company is making an issue through 100 % book building process then1) Minimum 35% shall be offered to Retail Investors 2) Minimum 15% shall be offered to Non-Institutional Investors 3) Maximum 50% shall be offered to Qualified Institutional Buyers. There can also be FPO (Follow on public offer) when company’s offer to the public is not for the first time. There are certain advantages attached with going public.

Capital can be used to pay off existing debt or to fund capital expenditure. Moreover, another advantage is an increased public awareness of a particular company as IPOs helps in attracting new potential customers which may ultimately leads to increase in the market share of a company. Before deciding whether to go public or not, a company must evaluate all the potential benefits or challenges that will arise. The book runners involved in the process (i. e. investment banks) are given the responsibility to find out the pros and cons of an IPO and determine whether it is favourable or not for the company.