When you are likely to start your share market journey, there are lots of things to know about. Without having proper knowledge on any topic, may lead to huge financial losses.
In this article, we will be talking about an integral and buzzword, IPO. While trading online, you may have heard so many times. But, if you are not aware of the topic, you may find this article worth reading.
So, let’s get started,
What is an IPO?
The IPO stands for the initial public offering. You may hear or read that XYZ company launched its IPO on the market. It is actually the process a company follows when they make their shares available for the public to purchase.
They launch some of their shares at a price point. However, the pricing for each share is set by the company, but the pricing remains the same as they offer. In most cases, after launching the IPO, the share price of a specific share reduces. For example, After launching the IPO of renowned digital wallet company Paytm, their share prices drop what they are asking for.
With very rare companies, the share price keeps at they are launched.
Why do companies offer IPO?
The main purpose of a company offering an IPO is to raise funds. If a company requires funds or new investments, the best option is to launch its IPO. The initial public offering is launched through the stock exchanges there investors are already in the line to purchase if the company is a good and reputed one.
Launching an IPO actually happens in two phases.
- The first part is the company promotes its IPO and tries to create hype amongst investors.
- The second one is they actually launch their IPO.
Now, how a company launches its IPO?
Well, there are lots of complicated processes that decide how their price would be or how they will even launch their share on the market. After all, it’s about investors’ money and the economic condition of any country depends on it directly.
However, let’s understand the process most simply.
When a company is going to launch its IPO, the first thing they do is, hire an investment banker. Investment banks are basically the investment arm of any bank. In India, if we talk about HDFC Bank, ICICI, Axis Bank, State Bank of India or PNB, or any other bank. All banks have their separate division that is directly linked to the share market. They invest bank’s assets through the share market to increase the bank’s revenue. However, they also work with companies to help launch their first IPO.
There are lots of legal processes that a company needs to fulfill before launching the issue. The investment banker helps them in that process.
Besides, they evaluate the company’s share price.
Each company launches its share prices on various aspects. It’s not that simple, that you bid a price and it’s final. The investment banker looks at all the aspects of the company.
Its business model, growth rate, ongoing projects, who are in the key positions, and more.
They also help to decide a company’s valuation, how they will allot the shares to the public, and more.
After that the company issues share prices. Depending on the process, there are two types of IPOs in the share market.
- Fixed Price IPO.
- Book Building IPO.
Let’s understand both types of IPOs in detail.
Fixed price IPO:
As the name suggests, the prices are fixed at the time of launch. Now market research and demand for shares are pre-determined in this type of IPO launch. Here the company only relies on the investment banker, and the prices are fixed the share price is launched.
However, nowadays, most companies do not follow this static process of share price determination. There are many drawbacks to that process. As the prices are pre-decided, if the share prices are not set precisely, investors would consider the bidding overrated. Ultimately, they will show less interest in buying the shares.
On the other hand,
Book Building IPO:
It is a dynamic process, where the price has been decided on various parameters.
Here the share price is not as fixed as the first option. Here, both the company and the investment banker use a price discovery mechanism. Here the price is determined with the investor’s participation. Instead of a fixed price point here, a price band is used.
Now, what does a price band mean?
The price band is basically a price range.
For example, a company is launching its IPO with a book-building method. The price band is set at Rs. 170-210.
That means each share price of the company may be anything between Rs190 to Rs.210.
Here the minimum price is called the floor price and the maximum price is called the cap price.
After that, the company decides the tick price. Here the tick price is a like a slab. If the company set the tick price at Rs. 5 that means, the share price can be Rs.190, 195 or 200 or 205, or even 210. If any investor wants to make a bid he has to make a bid on these prices.
Now the company asks to bid. For Rs.195 how many bids are people offering?
For Rs. 200 how many bids are the company getting?
The process happens like that. Now let’s understand the matter with this table.
Expected share price                 Bids
| 190 | 120,000 |
| 195 | 150,000 |
| 200 | 200,000 |
| 205 | 125,000 |
| 210 | 100,000 |
Now, look at the chart. The company has received maximum bidding at the price of Rs. 200 per share.
Now, that share price is called the cut-off price and the company will not allow you to buy the shares at that below price. If you are bidding a higher price, you can get the shares, but not the lesser ones.
Here when the company agrees to sell its share price at Rs200, the investors who have bided higher will get their excess money back.
By leveraging this process the company actually evaluates its share pricing.
From an investor’s point of view, there is a difference between investing in IPOs and regular share market investments.
Where the initial public offerings are denoted by IPO, the regular share market investment is known as FPO.
Difference between IPO and FPO:
For an investor understanding both options is extremely important. Both investment options have their evens and odds. So, before you make your move, let’s understand the topic through various aspects.
Price point:
In an IPO, the share price may be fixed or variable. Even though the price may change, according to the guidelines, the difference between the floor price and the cap price can’t be more than 20%.
On the other hand, the share price depends completely on the market trend. If the market is in good condition, the share price will rise up and if there are problems in the market, the prices drop.
Risks:
Even though the share market is always full of risks, if there is a comparison between IPO and share market investment, IPO is riskier. Companies that are new or just started a couple of years launch their IPO. There is a high chance there might not run smoothly. In that case, your share prices also drop.
Companies that are veterans and in on the market for a while, and faces lots of troublesome situation and are still on the market. Chances are minimal to collapse. Their roots are strong enough compared to new companies.
Profits:
In terms of profit, IPOs beat the share market investment. At the time of launch, the company is quite new and it is obvious people are less likely to trust them. That’s the reason, companies issue IPO at comparatively low pricing.
After launching the IPO, when the company is established on the share market, the share prices of them no wonder will rise high.
Now, if you bought a share of that company at the time of the IPO launch, you could be a gainer by selling them later with big margins.
Now, look towards the
Objectives:
As mentioned above a company issues its IPO when they need funds at its early stages.
Through regular stocks, companies raise funds to expand their business.
These are some differences between IPO and FPO.
Final words:
For many investors, investing in an IPO was one of the greatest decisions they had taken. Modern-day big companies such as Amazon, Google, or Apple when first time offered their IPO, the share price was considerably low. But now, the prices are skyrocketing.
But, that is only one side of the coin. There are many companies that could not grow as per the investor’s expectation and investors lose their money investing the.
However, investing in an IPO could be a great decision if you can dig deeper and analyze the company precisely.
Thanks for reading. Explore more relevant articles.
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