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Two different approaches are used to finalise the IPO share offer price. Know more about them and how to apply for one.
We are going through a listing boom in India at the moment. Twenty companies raised capital through Initial Public Offerings (IPOs) in less than three months since January 2021. In the pandemic-ridden previous nine months, 29 companies got newly listed on the Bombay Stock Exchange (BSE). While some of these shares have dipped below their listing price now, the IPOs are getting an overwhelming response, with some being oversubscribed by more than 100 times.
Types of IPO
Seasoned investors would know that there are two types of IPOs that a company going public can opt for.
Fixed price offering
A company hires a merchant banker before the IPO. The merchant banker evaluates the assets and liabilities of the company and does a risk assessment. Based on the findings, the merchant banker fixes a share price for the IPO.
Under this offering, a company agrees on a fixed share price and the investor is aware of this price. The investor applies for the shares during the IPO at this price. Apart from the offer price, there is also a face value of the share. For instance, a company may fix the face value of their shares at Rs 10 and put an offer price of Rs 70 on the shares during the IPO.
Related: What happens to your money if the stock you invested in gets delisted?
Book building offering
In this process, the share price is not a fixed amount. Instead, a price band is disclosed, based on which investors apply for the share allotment. The price band is decided by the company and the investors have to bid within this price range within a stipulated time. The upper limit of the price band is known as the cap price while the lower limit is called the floor price. The final share price will depend on the bids made by the investors. The investors pay for the shares only after the share allotment.
To understand the process better, here is an example. Let’s say a company is offering an IPO of 10,000 shares at a price band of Rs 70 to Rs 80. A total of 15,000 investors apply, with exactly 5000 investors bidding at Rs 70, Rs 75, and Rs 80 each. The company has 10,000 shares to issue, so it will consider the investors with higher bids. Accordingly, the 10,000 investors (5000 + 5000) bidding at Rs 75 and Rs 80 will be allotted shares. The share price will be fixed at Rs 75, and Rs 5 per share will be refunded to the 5000 investors who bid at Rs 80. All the investors who bid at Rs 70 per share will get their full money back.
Related: How IPOs differ from NFOs?
How to invest in an IPO
When it comes to applying for an IPO, you have to do some groundwork even before doing the paperwork. Study the company you want to apply to, read their draft red herring prospectus, look at their financials, find out their plans, where they plan to use the raised money etc. Given the instances of massive oversubscription in recent IPOs, it is a challenge for small retail investors to get IPO allocations. Make sure you have enough funds to apply for the new shares.
To be eligible for applying shares offered under an IPO, you must have a PAN issued by the income tax department, and a valid demat account. A trading account is not an immediate requirement unless you wish to subsequently sell the stocks after the allotment.
Related: IPOs that have disappointed investors in the last 10 years
Firstly, open a demat account with a depository participant or broker who is authorised to open an account for an investor. For this, you will have to furnish documents such as Aadhaar, PAN, identity and address proof, photograph etc.
To conduct transactions, you will also need to open a trading account with a stockbroking firm. You will also need the Applications Supported by Blocked Amount (ASBA) facility linked to your account so that your application money is blocked till allotment. You can then apply for IPO through your bank or trading account. Nowadays, brokers offer a demat-cum-trading account with bank account linked to it.
You can now bid for the shares as per the fixed price or the price band. You have to apply as per the lot size, where the lot is the minimum number of shares you need to apply for. Read more to know why you should take the ASBA route for IPO applications.
Related: ASBA and IPOs: All you need to know
As the governments and central banks globally are strengthening their economies through financial and policy support, some of the funds will find their way to the stock market. Besides, as the interest rates remain low, the attraction towards the equity market is set to continue. With several more high-profile IPOs in the offing, you would do well to understand the tricks of the IPO trade and invest wisely. What to keep in mind when investing in an IPO?