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Wednesday, May 25, 2022

Everyday Economics: What is an IPO?

While coming with an IPO, the company has to file its offer document with the market regulator Securities and Exchange Board of India (Sebi).

Written by Sandeep Singh |
Updated: February 16, 2022 3:15:25 pm
Following the IPO, the company is listed on the stock exchange (Image source: Getty/Thinkstock)

An IPO or initial public offering is the process by which a privately held company, or a company owned by the government such as LIC, raises funds by offering shares to the public or to new investors. Following the IPO, the company is listed on the stock exchange.

While coming with an IPO, the company has to file its offer document with the market regulator Securities and Exchange Board of India (Sebi). The offer document contains all relevant information about the company, its promoters, its projects, financial details, the object of raising the money, terms of the issue, etc.

Which companies can come out with an IPO?

In order to protect investors, Sebi has laid down rules that require companies to meet certain criteria before they can go to the public to raise funds. Among other conditions, the company must have net tangible assets of at least Rs 3 crore, and net worth of Rs 1 crore in each of the preceding three full years, and it must have a minimum average pre-tax profit of Rs 15 crore in at least three of the immediately preceding five years.

Where do the proceeds of the IPO go?

If the issue raises fresh capital, the proceeds of the IPO go to the company, and can be utilised for future growth, expansion, debt reduction, etc. If the issue involves offer for sale by promoters or existing investors, then the money goes to them and not to the company. In the case of LIC, the issue is an offer for sale by the government, and the IPO proceeds will go to the Government of India.

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Who fixes the price of securities in an issue?

The per-share price of the public issue is fixed by the issuer in consultation with the merchant banker. They arrive at the total valuation of the company based on parameters such as assets, revenues, profits, and future cash flow projections, and the total value of the company is then divided by the post-offer shares outstanding to arrive at the price of each share.

The regulator, Sebi, does not play a role in price fixation.

What are the advantages of listing a company?

While listing on the stock exchange calls for additional disclosures by companies on a regular basis, leading thereby to more stringent compliance requirements, it may help a company raise capital, and diversify and broaden its shareholder base.

Listing provides an exit to existing investors of the company. A listed company can raise share capital for growth and expansion in the future through a follow-on public offering or FPO.

Who can invest in an IPO?

There are various categories of investors who can invest in an IPO. Qualified institutional buyers (QIBs) is a category of investors that includes foreign portfolio investors (FPIs), mutual funds, commercial banks, insurance companies, pension funds, etc.

All individuals who invest up to Rs 2 lakh in an issue are classified as retail investors. Retail investors investing above Rs 2 lakh are classified as high net worth individuals.

You have to be 18 years of age to become an investor. A brokerage account is needed to invest, and you have to be at least 18 years old to have one.

What should you look for before investing?

The credibility of the promoter should be the top consideration. But investors must also do a financial analysis of the company, and compare it with peers in the same sector before investing in the IPO.

If there is a company in the same sector that is already listed, and if it has strong fundamentals and its shares are available at a competitive price, investors should consider that as well, rather than going for the public issue of a company that is proposing to list.

Investors must follow QIBs, who are perceived to have the expertise for assessment and evaluation, and a greater ability to do due diligence.

These institutional investors invest in the first few days of the issue opening, and retail investors, who have a wider window for investing, can assess the demand from the interest shown by the QIBs, and can simply follow them. If QIBs show a lot of interest, retail investors can go for the issue. If the QIBs are cold, it is better to avoid.

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