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What is an IPO?
Initial public offering (IPO) is the first public offering of shares of a private company. IPOs allow companies to raise equity capital from investors.
The transition from a private to a public company can be a good time for private investors to realize gains, as it usually includes a share premium. The offering is open to the public.
How Does an IPO Work?
An underwriter, usually an investment bank, is hired by a private company going public. Underwriters prepare management for an IPO by creating investor documents and scheduling roadshows.
The underwriter forms a syndicate of investment banking firms to distribute the new IPO shares. Each firm distributes a portion of the shares.
After the company and its advisors set the IPO price, the underwriter issues share to investors and the stock begins trading on a stock exchange.
Who issues an IPO?
IPOs involve “underwriters,” or investment banks. “Issuer” company contracts with lead underwriter to sell shares to public. Underwriters then approach investors to sell shares.
Terms associated with IPO
To understand IPO, one must know some basic terms. Some of the commonly used terms are: –
An issuer is a company that wants to sell shares on the secondary market to finance its operations
An underwriter can be a banker, FI, merchant banker, or broker. It helps the company underwrite its stocks. The underwriter promises to buy any unsold IPO shares
FIXED PRICE IPO & PRICE BAND
Fixed-price IPO is the price some companies set for the initial sale of their shares. A price band is a value-setting method in which a seller sets an upper and lower cost limit for bidders. Price range guides buyers
Underwriters and merchant bankers use book building to determine the IPO price. Underwriter makes a book with institutional investors' and fund managers' bids for shares and price
Types of IPO
Following are the two types of IPOs in India:
Fixed Price Issue
The company going public decides the price of its shares. In a fixed price offering, investors don't have to wait until allocation to know share price. The price is announced with the IPO. Subscribers pay the full price
Book Building Issue
Investment banker sets price of IPO. The price band is often 20%. Investors choose the IPO price. The price band's maximum price is the 'Cut-Off Price.' Minimum price is called 'Floor Price
Comparison of IPO with other products
|Definition||New fund offering (NFO). Asset Management Company launches a new fund.||IPO means new stocks. Companies issue these when listing for the first time.|
|Valuation||NFO invests the complete fund as units.||Performance drives IPO valuation. This is measured using P/E and P/V ratios.|
|Price||NFOs cost Rs. 10 each. NAV is based on market conditions, so this value is insignificant.||The valuation of IPO shares depends on company fundamentals and demand.|
|Usage Of Funds||NFO raises funds to invest in bonds and securities to profit from a lucrative theme.||IPO funds are used for expansion, debt repayment, and promoter stake reduction.|
|Listing||NFO invests funds based on NAV. This can be above or below the face value.||IPOs must be listed at or above a predetermined price range. If the price rises on the listing day, investors can gain substantially.|
|Risk||NFOs are for moderate-to-low-risk investors.||IPOs pose stock market risk.|
|Investors||No categorization.||IPOs are ideal for retail, institutional, HNI investors, etc.|
Benefits of IPO
How to invest in IPO?
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Why should you invest in IPO?
A company’s IPO specifies the minimum number of shares an investor can buy. This is the IPO bid lot or minimum order quantity. If a company specifies 100 shares as the minimum order quantity, an investor can only apply for multiples of 100. Investors can request 100, 200, 300, etc. shares.
Primary market is where investors buy shares directly from the issuer company.
Secondary market is where stocks are traded after being offered to investors in primary market (IPOs) and listed to stock exchange. Secondary market comprises equity and debt markets. Secondary market trades listed equities, while primary market is how companies enter secondary market.
IPOs are oversubscribed. This means share demand is higher than supply. In such a situation, many investors fail to get shares. It’s best to bid for IPO shares on the last day. So, one can estimate the subscription cost. Also, bid for just one lot and don’t lock up capital.
IPOs are tax-free. IPO shares aren’t taxed until they’re sold. IPO profits are capital gains. Longevity determines the capital gains tax rate. If you held the shares for more than a year, you would have long-term capital gains. Short-term gains are taxed at 15%. The long-term ROE is 10%. (years) Any equity gains over Rs. 1 lakh is taxable.
Book-building IPOs offer investors a 20% range to bid on shares. Bidding determines the final price. 20% price bands. Retail and institutional buyers must bid in this. The IPO floor price is the band’s bottom bid. It can’t be above the IPO cap. Bidders can revise while the book is open. Book building lets issuers set price and demand.