How does an IPO work?
Created on 27 Jan 2021
Wraps up in 5 Min
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Updated on 11 Sep 2022
A company's IPO is like its personal gateway to the public market. It drastically changes many things about the management work in the firm, and retail investors are offered a plethora of opportunities as well as potential dangers by companies presenting the IPOs. IPOs are seen very often during bull markets, and the recent rally in Indian Stock market is providing fertile soil for them to grow.
Owing to this scenario, the investing realm is currently full of IPO buzz. Hence, it becomes important for retail investors, especially for market beginners, to understand the IPO process and know who all are behind it, and also get to know the different steps in the IPO process.
So, let's get into it.
Definition of Initial Public Offering
An IPO (Initial Public Offering) is the process through which a private company goes public by offering its stock to the general public. The company raises capital by publicly issuing its shares.
The company that offers its shares is referred to as an "issuer". The issuer offers its shares with the help of an investment bank. After the release of the IPO, the shares of the company are traded in the open market.
Criteria for filing IPOs
Before understanding how an IPO works, let us understand the eligibility norms stated by SEBI for companies who want to register for an IPO -
- The company ought to own net tangible assets (described as material assets along with monetary assets of no less than 3 crore rupees in all the last three years. Virtual assets with a changing value such as shares are not included)
- The company must have an operating profit of at least 15 crores for three years in the last five years.
- The valuation of IPO can't surpass the company's value beyond five times.
Although the company can still submit a request for approval of IPO with SEBI if these criteria are not fulfilled.
In such a scenario where a company is not able to fulfil SEBI norms, the companies only have to take a book-building process, in which 75% of the stocks have to be sold to Qualified institutional Investors (QII). If the company can sell 75% of the stock to QII, then the IPO will legitimize; otherwise, it will be cancelled, and the raised capital will have to be refunded.
How IPOs work in India?
Hiring a team of experts
The IPO process begins with the company pooling together a team of experts which includes investment banks, underwriters, lawyers, accountants, etc. This team helps in filing an IPO application with the SEBI, helping in preparing a prospectus and other documents required in the IPO process.
This team also helps in getting potential investors, advertising about the IPO in the public domain. This team helps in determining the price range of the shares, the number of shares to be offered and other things.
Going through SEBI
SEBI is the market regulator which ensures that the share market operates fairly, and the interests of both the companies and the investors are secured.
After pooling the team of experts and preparing registration documents; the issuing company approached SEBI to get permission for an IPO launch.
The registration documents contain the following things such as:
- Business Summary
- Objectives of IPO
- Financial Structure of the company
- Capital Structure of the company
- Plans on fund Utilization
- Debts of the company; etc.
SEBI reviews the filing given by the company and evaluates all the details with their team of industry experts. SEBI also reviews all the disclosures, ranging from financial aspects to legal aspects, to policies, to the plan of raised capital utilization, and others.
If there are any discrepancies or any other problems, SEBI gives a comment letter to the issuing company. The issuing company and their team of experts, then rework on the comments received from the SEBI. After that, the issuing company resends the registration document to SEBI.
SEBI reviews the registration documents again and approves only if the issuing company has followed all the process and regulations.
After that, the company sends a prospectus which is again reviewed by the SEBI and more comments are sent, if required.
Organizing a Roadshow
The issuing company, along with its underwriting team, goes around the country to advertise about the offer and to get investors for the issue. The motive behind this roadshow is to create a hype about the issue in the public domain.
Sometimes, companies also tend to offer a special deal to a set of investors to buy the stocks at a pre-set price in advance before the IPO begins. This step further helps the company to get an overall response about the IPO and to get an outlook about the valuation of the company from the investors' perspective.
After this, the issuing company analyses the response and moves ahead.
Fixing the IPO pricing
The underwriting team fixes the price range of the IPO, and a bidding process is started, which is usually carried by an investment bank.
The perfect share price is decided, which keeps the demand slightly higher than supply. This attracts investors to invest in the IPO and also helps in stabilizing the market price after the company gets listed in the stock exchanges.
Timing it well
After fixing the price range, the next big question which comes in front of the issuing company is about when to launch the IPO.
Timing is an extremely important factor in an IPO issue. A company cannot propose an IPO anytime it wishes to. During bear markets, the moods of investors are usually down, and so, most probably the investors will not show the same amount of enthusiasm about the IPO as they would have shown during a bull market. Hence, companies prefer to launch IPOs during a bull market.
In a scenario where a big industrial giant is launching an IPO, a smaller company will try to avoid that period to enter the market. This is because the buzz of the giant company's IPO will overshadow the smaller company's IPO.
Owing to these reasons, before launching an IPO, a company has to plan everything accordingly so that they can utilize the timing perfectly.
The entire IPO process takes around 6 months to complete. It is always beneficial for investors to know about all the procedures done by a company before and after launching an IPO.
Such information is always useful in making a well-informed investment decision.
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