Initial public offering (IPO)

Initial public offering (IPO) is a form of public offering where shares of a company are sold to institutional investors and also to individual investors. An IPO is usually underwritten by one or more investment banks. Who arranges for the shares to be listed on one or more stock exchanges. Talking of stock exchange you can also read about SEBI. Allotment of IPO in different cases will be discussed in this article

Initial public offerings can be used:

  • for raising new equity capital for the company concerned.
  • monetization of the investments of private shareholders such as company founders or private equity investors. To know more about the Best equity mutual funds to invest read this article.
  • to enable easy trading of existing holdings or future capital raising by becoming publicly traded enterprises.

Although IPO is offering many benefits, there are also significant costs involved. Mostly those associated with the process such as banking and legal fees, and the ongoing requirement to disclose important and sometimes sensitive information.

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Allotment of IPO

Initial Public Offerings (IPOs) usually get good participation from retail investors. The allotment of shares to investor categories is reserved in each and every IPO. The categories are – qualified institutional buyers, non-institutional investors, and retail investors. Most of the time, the quota of shares reserved for the retail investors gets over-subscribed. Over-subscription means when the number of applicants exceeds the number of shares that are being offered. So, when an issue is over-subscribed, the applicants get fewer shares than they have applied for. If there is no over-subscription, the investors get a full allotment of shares.

Process of Allotment when an issue is over-subscribed

IPO Allotment to Qualified Institutional Buyers

In the case of Qualified Institutional Buyers (QIB), the authority to allot shares is at the discretion of the merchant banker. Shares are allotted proportionately to the applicants. So, if the shares are oversubscribed by 4 times, then an applicant who applied for 10,00,000 shares will receive only 2,50,000 shares.

IPO Allotment to Retail Individual Investors

As far as the Retail Individual Investors (RIIs) are concerned, the process for the allocation of shares is different. The maximum amount which the retail investors can apply for per IPO is Rs. 2 lakh. In order for the determination of the total demand for shares in the retail investor category, all the applications are grouped together and the total number of applications is calculated. For calculation, the total number of equity shares available for allotment to RIIs is divided by the minimum bid lot. This will provide us the maximum number of RIIs who can be allotted the shares.

For example – If shares worth Rs. 20 lakh need to be allotted to the retail segment and the minimum lot size is Rs. 10,000, only a maximum of 200 applicants will be allotted the shares with a minimum lot of Rs. 10,000.

If the number of RIIs exceeds the maximum RII allottees, the RIIs (in that category) who will be eligible for the minimum bid lot will be determined on the basis of a draw of lots. This is a computerized process and hence there is no room for partiality.

High Net-worth Individuals

Usually, High Net-Worth Individuals (HNI) invest a large amount of money in IPOs. Financial institutions provide the required funding to HNIs in order to invest in IPOs. It is not necessary that an HNI will be allotted the exact number of shares that he has applied for. If there is an over-subscription, the HNIs may be allotted fewer shares than what they must have applied for. For example, An HNI client has filed an application for 10 lakh shares and the HNI quota is oversubscribed by 150 times. The total shares will be allotted to the HNI applicant will be 6666. This number derives by dividing the total number of shares applied for by the number of times that it has been over-subscribed.

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Advantages of IPO

An IPO has several benefits to the previously private company:

  • Enlarging and diversifying equity base.
  • Enabling cheaper access to capital.
  • Increasing exposure, prestige, and public image.
  • Attracting and retaining better management and employees with the help of liquid equity participation.
  • Facilitation of acquisitions (potentially in return for shares of stock).
  • Creation of multiple financial opportunities: equity, convertible debt, debt, cheaper bank loans, etc.

Also read: 10 short term debt funds you must consider for investing

Disadvantages of IPO

The following are the disadvantages of completing an initial public offering:

  • Significant legal, accounting, and marketing costs, many of which will be ongoing.
  • The requirement for disclosing financial and business information.
  • Meaningful time, effort and attention requirement for management.
  • The risk requiring funding will not be raised.
  • Dissemination of information which can be useful to competitors, suppliers, and customers.
  • Loss of control and stronger agency problems due to the new shareholders.
  • Increase in risk of litigation, including private securities class actions and shareholder derivative actions.

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