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3 Steps on How to Invest in IPO’s

25 Mar 2020

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WHAT IS AN IPO?

There are numerous companies out there that require funds for various reasons, be it growth or expansion, or clearing debts, etc. Sometimes, these companies decide to go public and offer their stocks to be sold as shares in the market, to obtain these funds. This procedure is referred to as Initial Public Offering (IPO).

The company could also approach a bank for money as a loan, as you would imagine, however, that requires them to pay interest. Initial Public Offering, therefore, is a risky yet smart move made by these companies to quickly raise some funds for their requirements. 

HOW DO IPO’s WORK?

To break it down further, the shares that are sold by these companies as IPO’s, are used to create capital. There are two ways by which companies issue these shares:

  1.  The company issues fresh shares in the market to the public.
  2. The company may allow the existing shareholders to sell their shares to the public without raising any fresh capital. Usually, the investors buying these shares also get part ownership in the company, and they are often given a say in the business decisions carried out by the company. For example, they may get a vote on deciding the board of Directors of the company. Once the company is listed in the stock market, the shares can be sold and bought, between investors.

An IPO cannot be suddenly issued, there are various steps the company has to carry out to do so. 

  1. The company first appoints underwriters who sell stock to the public, 
  2. They register the company issuing IPO with the Securities & Exchange Board of India (SEBI) 
  3. They organize roadshows and other such forms of public awareness drive to sell the IPO to the public.
  4. The IPO is then open to investors for investment. 
  5. The first issue is usually done in the primary market, where the shares are often issued to high net-worth individuals and qualified institutional buyers. 
  6. After the first issue closes, the stock gets listed on stock exchanges like the Bombay Stock Exchange and the National Stock Exchange, where the shares can further be freely bought and sold amongst other investors. Based on the amounts invested, you will fall under one of the below-mentioned categories.

TYPES OF IPO INVESTMENTS:

Types of IPO Investments

1. Retail Institutional Investors:

Investors who invest below Rs.2,00,000 fall under the RII category. You could be an NRI or resident and apply under this category. Around 35% of the issued shares are reserved for those in the categories.

2. Non- Institutional Investors:

Companies, corporate bodies, scientific institutions, societies and trusts who invest more than Rs.2,00,000 are called NII’s. However resident Indian individuals and eligible NRIs, who invest more than Rs.2,00,000 are categorized as HNI (High Net-worth Individuals). A minimum of 15% of the shares is reserved for this category. SEBI registration is not required for those in this category.

3. Qualified Institutional Bidders:

Public financial institutions, commercial banks, mutual funds and NRI’s, etc, can apply in the QIB category. SEBI registration is required and not more than 50% of the shares issued under this IPO are reserved for QIB’s.

TYPES OF IPO:

From the pricing perspective, IPOs can be divided into two –

  1. Fixed price issue: In a fixed price issue, the company that is coming out with an IPO sets the price beforehand, and this is mentioned in the prospectus.
  2. Book built issue: In a book-built issue, no price is fixed previously. Instead, it is decided based on the investors’ demand. Investors have to bid within a price band, and the difference between the floor and ceiling of the band should not be more than 20%, which is usually determined by the company.

HOW TO INVEST IN AN IPO:

How to Invest in an IPO

Step 1: Opening an IPO account:

You may open an IPO account (often called Trading Account) either through brokerage companies across the country or online. In order to apply, you will have to fill an account opening form which requires submission of documents like PAN card, Aadhar Card, Passport, etc. Along with this account, you also have to create a Demat account to buy and sell shares.

Once verification is carried out by the company, you can begin to sell and buy IPOs. In the case of an online application, the forms are to be filed online, and the rest of the process can be tracked by you personally. Your Demat account will also be linked directly to your online account.

Step 2: Do your research:

The next step is to identify which company is going public, and then determine which is best for you. But since these companies are usually private, reliable public information on them can be scarce. Do as much research, either through brokers, or online, or other trusted third-parties. Take into consideration the market – how well it is doing, management – track records of their ups and downs and money – how much debt they have, and their profitability.

Read the prospectus which is issued by the company to gain a complete understanding of the IPO. Also, consider the underwriters of the public issue as well because reputed underwriters tend to be a lot more trust-worthy. 

Some websites which provide information on upcoming IPOs include:

Step 3: Determine where to invest:

Once you do thorough research, go ahead and invest in the IPO. Keep in mind the risk that generally comes along with investment. Always proceed with caution, and invest only in businesses you are familiar with to reduce risk relatively. If you aren’t 100% confident, approach an investment advisor.

FAQ’s on How to Invest in IPO’s?

  1. I’m 19, can I invest in IPOs? 

Of course, any adult over 18 years can invest, however it does require you to have a PAN card and a Demat account in order for you to proceed.

  1. Can an NRI invest in IPO’s in India?

Yes, as per the laws, Non-resident Indians can also invest in IPOs. However, there are separate requirements if you are an NRI. You will have to open an NRI Demat account instead of a regular one.

  1. I have limited money (a small investor), but would like to invest in IPOs, but can I afford to?

Under SEBI (Securities and Exchange Board of India) guidelines, small investors get preferential treatment in the allotment of shares and also get a discount on the price. So this presents an opportunity for small investors as well. 

  1. What is the lock-up period and why is it important?

The period where the underwriters and company insiders are prohibited from selling shares in the secondary market is called the lock-in period. It could range from a few days to a couple of years, however prices of the stock often fall sharply when insiders and underwriters sell the stock, so be cautious during this period.

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