IPO (Initial Public Offer) in India - Explained in Brief

Published on Wednesday, August 15, 2018 by Chittorgarh.com Team | Modified on Wednesday, November 13, 2019

IPO is the short form for the Initial Public Offering. It is a sale of shares by a company to the public for the first time. Without an IPO a company remains a privately held company. The privately held company have a small number of shareholders. These shareholders may range from promoters, who are the owners of the company, their family members, friends, and relatives. Some strategic or professional investors may also hold the shares of a private company like venture capitalists, angel investors or private equity investors.

However, after the IPO process which informally is also known as going public, the number of shareholders increases multifold, when compared to the privately held company. IPO allows individuals like you and me and institutional investors to purchase and sell shares of the company. With this initial offering, a company's share becomes eligible for a stock exchange listing. Stock exchange listing facilitates in buying and selling of such shares of companies.

Advantages of IPO for a company

• Large and diverse group of investors
• Lower cost of capital to the company
• The largest amount of capital to be raised compared to other options
• Exposure, prestige, and public image of the company improve. This may help speed up growth
• May attract and retain better management and skilled employees
• Helps in further acquisitions (potentially in return for shares of stock)

Disadvantages for a company going public

• Disclosure and compliance requirement in financial, accounting, tax, and other business information field increases. This results in a significant rise in legal, accounting and marketing costs.
• Also, legal and regulatory risks such as lawsuits and shareholder actions rise. Moreover, time and efforts required of management for reporting rises
• Many Information which may be confidential in nature goes to competitors, suppliers and customers offer listing.
• The company may lose control to new shareholders, who might obtain voting rights and can effectively control company decisions through the board of directors

An IPO may also give exit options to the company owners and other initial investors by way of offer for sale. This helps them to profit from the early risk that they took in the form of the new venture.

What to look before investing through an IPO?

Analyzing a well-established listed company from an investment point of view is a tough job. It became more tough and trickier if you are going to analyze any company whom you want to invest through its IPO. There is almost nil historical information available on the public domain to start with. The only source of data about such companies is their red herring prospectus (RHP) or the draft RHP. Thus, this is the document which needs to be scanned with utmost care before making any investment decision in the said IPO. Particularly one should look for the following in any company before making a decision to invest.

Points to consider before investing through IPO

• Usual information on the management team, their qualification, experiences, legal aspects of the management personals and their expertise. A good company is one whose management have expertise and experience in line with the business of the company they are handling.
• Consider how the management plan to use the funds generated from the IPO if it is not offered for sale (OFS). In an OFS no proceeding from the sale of the share goes to the company, rather it goes directly to the selling shareholders. If the money collected through the IPO is to repay long-term debt or it is being used for expansion of the business in the phased manner it is generally considered good.
• Compare with the performance of similar companies who are already public. This will give you a sense of the overall performance of the sector in which the company is operating. Particularly look for margins of the companies and variations in Q-o-Q revenue of different companies, if any.
• Always invest in an IPOs that have good operating margins and at the same time lower valuation in comparison with established and reputed peers.
• Also, give proper attention to the quality of the underwriters and their deals with the company. IPOs that are successful are generally supported by brokerages who are capable to promote new issue well. Smaller investment banks generally underwrite any company and thus bear no valuable information for investors.

The underwriters and investment banks act like salesmen to an IPO they are dealing with. They stand in between companies and investing public. Actually, a company can't directly go to the market to sell their share. It needs to be done through proper mechanism.

Stock exchange provides a platform that facilitates such a transaction. Brokers are intermediaries then executes buy and sell transactions. Likewise, are underwriters and investment bankers. They facilitate the company with the IPO proceedings. Also, the underwriters have the obligation to buy all shares under offer, in case of no buyers of the shares during IPO proceedings. As per SEBI, some portion needs to be subscribed so that underwriters can exercise their rights of underwritings.

What are the different types of IPO?

IPO gives dual benefit to a company opting for that route. It gives an exit strategy to maximizes the returns of early phase investors and at the same time help raise capital for the business at minimum cost. Companies can come up with IPO either through Public Issue or Offer for Sale (OFS) or combination of both. Under Public Issue, companies sell a portion of their issued capital to investors. While in OFS, the existing shareholders sell all or portion of their holding to the investors. The proceedings from Public Issue goes to the issuing company while OFS proceeds go directly to the selling shareholders.

Raising capital through IPO is a primary market activity and companies are allowed to do so either on Fixed Price or Book Building basis or a combination of both. The following table will help you understand the basic difference between the two.

Thus, a company has a variety of option to come up with the initial public offering. The public issue with Fixed Price, Public Issue with Book Building or Fixed Price Offer for Sale, OFS on Book Building basis, and a combination of Public Issue and OFS are some of the available options.

How SME IPO different from main IPO's?

India SME's are playing a prominent role not only in employing workforce but also in GDP growth. According to some estimate SME in India employees above 40% of the workforce and over 45% of total manufacturing output.

But the major problem with most of these SME's is access to proper financing. Besides traditional financing facilities, they don't have many options left. So, in order to give them an additional funding option both NSE and BSE came up with a separate window for them to access the capital market. The major hurdle was that the current regulation has made it difficult for them to tap the capital market route for funds raising.

BSE named SME platform as 'BSE SME' while NSE as 'EMERGE'. These platforms opened a new chapter in the history of the capital market in India. It opened the gate for SME's to tap these high potential market for funds raising.

The following table differentiates SME IPO form that of main IPO.