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What is Initial Public Offering (IPO)?

An Initial Public Offer (IPO) is a way through which growth-oriented companies offer their share to the general public for the first time. The motive behind going for an IPO issue is to raise capital and fuel future growth. The different types of IPO are fixed price issue and book building issue.

The IPO process is simple: the corporation sells its securities to the general public. When the public purchases a firm’s shares, the company receives a capital injection.

Thus, everyone who has invested in a certain firm has the option to obtain the company’s wealth, which is proportional to their shareholding. If a company performs well and produces a substantial profit, shareholders receive enormous amounts of money from their shares. If all goes well, the company’s connection with the public will be mutually beneficial.

What are the Types of IPO in India?

Following are the two types of IPOs in India:

  • Fixed Price Issue
  • Book Building Issue

Fixed Price Issue

In a fixed price issue, the IPO price is fixed. In other words, the merchant banker and the company going for an IPO together decide the price at which the public can subscribe to the company’s shares. Before concluding the price, the merchant banker assesses the company’s risk levels, assets, liabilities, existing value, and future prospects.

In a fixed price offering, investors do not have to wait until the allocation date to know the price of each share. The price is disclosed at the time of announcing the IPO itself. Thus, investors pay the total price while subscribing. Unlike book building issues, the status of a subscription in a fixed price issue is not known until after the issue closes.

Example

Let’s understand the fixed price issue with an example. For instance, XYZ is a private limited company that wishes to raise money through a fixed price issue IPO.

XYZ company hires a merchant banker to assess the company’s assets and liabilities, as well as its growth potential, to establish the price for each share. The banker decides the face value of each share to be INR 100 and that the public offering price to be INR 1500.

XYZ company will then submit an IPO application to SEBI upon fixing a price. SEBI then requests the company to provide the Draft Red Herring Prospectus (DRHP). The DRHP contains essential information regarding the company’s management, business, finances, reasons for going public, business risks, etc. If the DRHP is as per SEBI’s requirements, the company is permitted to list on the stock exchange. The company then promotes its IPO issue media to attract investors.

Book Building Issue

In a book building issue, the price of the IPO is determined by the investment banker. After a thorough analysis of the company and discussions with the company officials, the investment banker will decide on a price band. The pricing band is often within a 20% range. To place bids, investors may select any price within the price band. Therefore, investors are free to choose the price they wish to pay for the IPO. However, it must be within the price range/ band. The maximum price in the price band is referred to as the ‘Cut-Off Price.’ On the other hand, the minimum price is referred to as the ‘Floor Price.’

The company reveals the entire number of shares it intends to sell in a book-building issue. Furthermore, the company will share information with SEBI and the public about the shareholders who are selling their stakes. The IPO’s final price depends on the number of bids received. If the issue is oversubscribed, the initial public offering price is set at the cut-off price. In this type of IPO, the investor’s account is debited only after the shares are allotted.

Example

Let’s understand the book building issue with an example. For instance, ABC is a private limited company that wishes to raise money through IPO to fund its growth plans. ABC company will hire a merchant banker to assist with the application procedure. The merchant banker evaluates the company’s growth potential and financial standing before determining the likely price investors will pay for each share.

Post the analysis and calculation. The company decides to issue 10,00,000 shares to the public. The merchant banker and the company decide on the price band to be INR 1,000 – 1,050. An investor’s minimum price for the IPO issue is INR 1,000, and the maximum price (cut off price) is INR 1,050.

After the offer period ends, the firm reviews the IPO bids. The following are the bids received for the issue:

  • 2,00,000 bids for 1,000
  • 4,00,000 bids for 1,020
  • 6,00,000 bids for 1,040
  • 5,00,000 bids for 1,050

Since the offer for 10,00,000 shares is at or above INR 1,040, all bids below INR 1,040 will not receive shares.

For a book building issue, the company releases the IPO subscription status on a daily basis. The subscription data will help investors assess the demand for the IPO.

Book Building vs Fixed Price Issue

Following are the key difference between fixed price issue and book building issue:

Basis of DifferenceFixed Price IssueBook Building Issue
PriceThe share issue price is fixed and is printed in the order document.IPO share price is not fixed but is in a range. The price range is known as the price band. It is fixed after the issue closes.
SubscriptionThe subscription percentage for the IPO issue is known only after the issue closes.Subscription for the IPO is disclosed every day when the issue is open. Thus, investors can understand the demand for the IPO easily.
DemandFixed price issue may undervalue the company’s share. Thus, the shares have a high demand.The book building procedure is substantially more effective. The equilibrium between demand and supply determines the share price. Since the price is determined after the IPO closes, it is mutually advantageous. The investor receives a possible gain, while the corporation receives a reasonable return.
PaymentInvestors have to pay 100% while subscribing to the IPO. In the case of non-allotment, the amount is refunded.The investor account is debited once the shares are allotted to them and not before.
ReservationsInvestments below INR 2 Lakhs: 50% reservation
High Net worth Individuals (HNIs): 50% reservation
Qualified Institutional Buyers (QIBs): 50% reservation
Small Investors: 35% reservation
Other Investors: Remaining 15%

Conclusion

Fixed price and book building issues are the two types of IPO issues. The two types of IPOs differ in terms of the issue price, payment and demand. Prior to 1999, India’s IPOs were only offered under the fixed-price issue. However, book-building is more favourable globally and domestically because investors acquire shares at a reasonable price. Thus, offering a potential upside to investors and also issuing company obtains fair compensation for selling its stock.

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