IPO exit strategy: What should you follow to optimise your gains?

Recent IPOs have taught us that betting on stocks can go either way, depending on the timing of the public offer. If you have been allotted shares during an IPO, the next most important aspect to consider is an exit strategy that can help you optimise your gains. In this connection, a few changes have been introduced by SEBI recently amidst the IPO frenzy. These tightened norms are in the best interest of the investor and to protect the market against steep crashes on the listing. Let’s take a closer look.

New norms for IPO exits

The lock-in period for anchor investors has been extended to 90 days, and the maximum amount that can be sold by the majority of the investors through an offer for sale has also been capped. In this context, it is important to understand who an anchor investor is:

• Any qualified institutional investor (QII) who applies for at least Rs 10 crore during a public offering, which is usually carried out through the book-building process.
• Shares in an IPO are offered to such anchor investors a day before the opening of the IPO.
• A lock-in period is applicable, which forbids the anchor investor from selling their shares within a stipulated 30-day period.
• No other family member, relative, promoter, or merchant banker is allowed to apply for shares under the investor category.
• In a situation when the price fixed through the book-building process is higher than the price at which the shares have been allotted to anchor investors, the anchor investor will be required to bring in additional funds.
• However, if the price fixed through book-building is lower than the price at which the shares are allotted to anchor investors, the additional funds are not refunded.

A 30-day lock-in period for 50% of the shares is applicable for investments made by anchor investors. The remaining portion has a lock-in of 90 days. SEBI indicates that only investors holding over 20% of the shares in any company are allowed to sell a maximum of 50% of their shares through public offers. These measures have been put in place to reduce price volatility after the listing.

Also Read: Which Will Be The Top 5 Blockbuster IPOs Of 2022

Utilisation of IPO proceeds

To stabilise and rationalise IPO prices, a few more restrictions and norms have been put in place by SEBI to ensure that the IPO proceeds are utilised appropriately with the intent to achieve the stated business objectives. Here are some of the restrictions in this regard:

• Only up to 25% of funds raised through IPO can be used for unidentified acquisitions.
• For other acquisitions, the upper limit is capped at 35% of the funds raised through the public offering.
• Consistent monitoring by rating agencies to ensure the utilisation of funds is in the best interest of stakeholders.

Reasons for launching an IPO

An IPO allows a company to grow and enter the next phase, enhance its credibility, and build brand strength. It can boost a company’s market valuation, market share, and liquidity. But there are other reasons as well for companies to launch an IPO, such as:

• It provides an exit route to private investors.
• IPO timeline is aligned to the expiry of private investors’ private equity, thereby enabling them to offer their holding to the public.
• Returns generated from the public offer is usually multi-fold, and the potential upside is unprecedented.

Now that we have understood the new norms and the reasons behind public offers, it is important to understand the IPO investment strategy and exit strategy to ensure the optimisation of returns. The best time to buy and sell a stock depends on which direction the market is moving. It takes a trained eye with adequate experience and knowledge to time the market for buying and selling stocks. 

Also Read: Market Timing Vs Time In The Market: Missing 20 Best Days Would Have Reduced Your Returns To Half

Investment aspects to consider as part of the IPO investment strategy

• Utilisation of funds: The prospectus will mention in detail how the company intends to use the capital raised. It is important to know this aspect.
• Management and promoter background: Understanding the background of the promoters and management and evaluating their experience and track record will provide insight into their ability to implement ethical business practices and robust corporate governance. 
• Presence of a merchant banker: An established investment banker would have conducted thorough due diligence, which will work in your favour.

Apart from the evaluation of the company, its performance and prospects, it is important to fill out the application form in the most appropriate manner to ensure that it is not rejected. 

IPO exit strategies

IPO itself is an exit strategy for private investors. However, if you have invested in an IPO, you have to consider the right manner to exit the holding to optimise your returns. The exit strategy has to be aligned with your investment intent and the company’s prospects. Let’s take a closer look at some exit strategies.

• Flipping: There are investors who acquire shares in an IPO and sell them on the very first day of trading. On the day a stock is listed in the secondary market, it is typically in high demand, which inflates the price further. This is often seen as an opportunity to exit the shares that were allotted as part of the IPO process. This practice of exiting the stocks on the listing is called flipping. It is discouraged by market regulators, underwriters, and the company too, since it pulls down the prices soon after listing, sending out a signal that the IPO price was inflated. 
• Long-term investing: IPOs can be a mode of conducting long-term investment. There are many instances when the IPO price remains the lowest entry point, and this could provide substantial returns to the investor, especially over the long haul. If you were to look at any of the large-cap/growth stocks today, you can see an upward trend over the past 10-20 years if you ignore the intermittent drops. Many investors have stayed patient with their investment in IPOs and have seen phenomenal returns over the long term. If the company looks promising and a thorough evaluation indicates it will perform well over the next decade, the IPO could be a good point to enter and hold the stock till it achieves the desired returns. This strategy is synonymous with the buy-hold strategy that is often followed by passive investors. 
• Adherence to lock-in period: Private investors often have a lock-in period ranging from three months to two years. This is to avoid any sharp drop in share value. Such investors often sign an agreement with the management via the underwriters, which explicitly forbids them to sell the shares of the company when it debuts in the stock market. This initiative is undertaken by the underwriters/company to ensure that the stock’s valuation does not fall on listing in the secondary market, thereby ruining the reputation of both entities. 

Also Read: A Woman's Guide To Investing In IPOs

It is advisable that you look at IPOs from a long term investment perspective. These are investments that could turn out to be multi-baggers. This should be done only if you have properly evaluated the future prospects of the stock and have made a concrete observation that the stock is likely to perform well over the next decade or so. 

Although it is impossible to foresee any dynamic change in the ecosystem, all things remaining conducive for business growth should be indicative of the robust growth of the company in which you invest. However, if the stock were to correct sharply on the listing, then it is time to re-evaluate your position. The reason for the sharp loss should be evaluated, and an appropriate decision has to be undertaken. 

As a long term passive investor, if the stock continues to correct and stays below 50% of the listing price for over 6 months without any rebound, then it is best to cut your losses and look for an alternate investment. For an active investor, the stop loss is more robust and the time period to cut losses is lower.