The deluge

In November 2021, Nykaa – an e-commerce platform that sells beauty, wellness and fashion products and the first Indian unicorn start up headed by a woman, began trading on the Indian stock exchanges. The company went public by making an initial public offering (IPO). The IPO was considered an instant hit with the market capitalization of Nykaa crossing the Rs. 1 lakh crores mark.

The month also witnessed another IPO. The Indian digital payments and financial services firm, Paytm also made its debut on the stock exchange with a market capitalization expected to cross the Rs. 1 lakh crore mark.

In July 2021, Zomato the Indian restaurant aggregator and food delivery service provider went public with its IPO. Post the IPO, its market capitalization was more than Rs. 98, 700 crores.

The IPO bug has not bit only new age technology companies. Indian Railway Catering and Tourism Corporation (IRCTC) offered an IPO in October 2019. The credit card arm of the State Bank of India (SBI Cards) launched an IPO in March 2020. Even the Life Insurance Corporation of India (LIC), a government owned insurance and investment corporation is planning to go public with its IPO by March 2022. This is a part of the government’s disinvestment strategy. It’s raining IPOs!

IPO is the current buzz word. India has seen the maximum number of IPOs in 2021. With a whole bunch of companies (pharmaceutical, financial services and infrastructure) pegged to go public with IPOs in 2021, let us decode the IPO for the common man who may become an investor in the future.

What is an IPO?

Funds are required by a company for various purposes – enhancing liquidity, meeting expenditure, expansion, purchase of assets, repayment of loans etc.

In private / family-owned companies, members of a family or their relatives are the directors as well as shareholders. As directors, they are part of the Management and run the day-to-day operations and affairs of the company. As shareholders, they invest money initially at the time of company formation as well as whenever funds are required for the company. Usually, private companies source funds from within the family and or though angel investors / venture capitalists.

However, when large quantum of funds are required which cannot be sourced internally, then the private company seeks to become a public company by offering / allotting shares to the public at large.

Simply put, an IPO is a process that transforms a private company into a public company. When a private company offers shares to the public for the first time, it is called an initial public offering (IPO). Such an offering is made to individual retail investors (general public) and institutional investors (banks, government companies, pension funds, hedge funds, mutual funds etc).

Statute(s) governing the IPO

The IPO of any company in India is primarily governed by the Companies Act, 2013 and provisions of the Securities and Exchange Board of India Act 1992 (SEBI).

How does an IPO work?

• Appointing an investment bank / underwriter: The company seeking to issue an IPO usually appoint an investment bank or underwriter to act as an intermediary between the company and the investing public. Such investment banks or underwriter will enter into an underwriting agreement with the company. Besides, an investment bank determines the value / valuation of a company. For instance: For its IPO, Nykaa appointed investment banks – Kotak Mahindra Capital, Morgan Stanley, Bank of America, Citibank and ICICI Securities.
• Draft Red Herring Prospectus (DRHP): This is the most crucial aspect of an IPO, both for the company as well as the investor. The company has to prepare a draft prospectus (called Red Herring Prospectus) – a preliminary document containing key information – company’s objectives, operations, financial performance, promoters, risks, fund utilization, projected performance etc. Except for information such as price of the share, number of shares to be offered in the IPO and related information, all other information is included in the Red Herring prospectus.
• Approval by ROC & SEBI: The DRHP has to be submitted by the Registrar of Companies (ROC) and SEBI. opportunity is given to the company to make any corrections or revision in the DRHP. Once both approve, the company has to submit the (final) prospectus to the ROC & SEBI. the ROC & SEBI have to approve the prospectus as well. Once approved, no changes can be made to the prospectus.
• Application to the Stock exchange: Once approved, the company can make an application to the desired stock exchange where it seeks to trade its shares.
• Marketing the IPO /Branding exercise: Once the date of IPO is decided and application made to the stock exchange(s), the underwriter / investment bank and company executives go all out to market the initial public offering of the company to investors. Advertising, road shows and online and offline methods are used in creating awareness about the IPO.
• Fixing the price of shares for the IPO: The company can decide and fix the price. There are two ways of fixing the price – Fixed price or Book building.
  Fixed price – the price at which shares are to be offered is fixed in advance and announced by the company.
  Book building – the company expressly states a 20% price range. Investors can bid for shares within that price range. Both the minimum and maximum price cap in is expressly provided by the company. The final price at which shares are offered is decided once the bidding closes. Normally the offer is open between 3 – 5 days. Such final price is called the cut off price.
• Allotment of shares: Once the bid / offer is closed, the company decides on the number of shares to be allotted to each investor. If the subscription to initial offer is equal to or less than shares offered by the company, then each investor will be allotted at least one lot of shares. However, if the IPO is oversubscribed (investors seeking shares are more than the number of shares), then investors will be allotted proportionate shares only. The Nykaa IPO was oversubscribed by 82 times).

First time investor in an IPO

Investing in an IPO is like entering into uncharted territory. Since the IPO itself is a first for private company to become a public company, there is limited information available of such company.

It is very crucial for any investor, especially a first-time investor to be fully aware before investing in an IPO. The numbers, compliance and hype can make an IPO look very complicated. This is especially true for a first time individual / retail investor.

However, IPO is not all rocket science. Some basic must know for first time investors:

1. A retail / individual investor can apply for shares up to Rs 2 lakhs. Application for any amount above Rs. 2 lakhs and the investor will be considered as High net worth individual (HNI) or non institutional bidders.
2. A first-time retail investor must have a Demat account and trading account in addition to a bank account, valid mobile number and other requisite documentation for address and identity (PAN card etc.). Application for shares can be submitted physically or online. Care must be taken in submitting correct information in this regard else the application may be rejected.
3. Reading and analysing the details contained in the draft Red Herring Prospectus / Prospectus is absolutely essential for an investor. Specific attention must be given to:
   (i) The history and background of the company;
   (ii) Performance of the company which would be reflected in the financials of the company; to get a better idea, comparison can be made with peers in the same sector / industry.
   (iii) Promoters and Management of the company; their background, track record of performance.
   (iv) Utilization of funds – if majority of funds raised are going to be used for expansion of business, there is a good chance, the company’s performance will improve.
   (v) Litigation(s) involving the company. Whether the litigation ended favourably or unfavourably as it would impact the image of the company.
   (vi) Risks / Risk factors of the company
4. IPO is investing in the equity of a company. The investor has to determine his / her investment goal – short term gains or long-term equity growth. Increased profits mean more dividend, bonus being given to shareholders. When shares are bought / sold during an IPO based on valuation induced high price, the investor tends to make short terms profits. Traditionally, investment in equity has yielded long term sustainable growth.
5. The investor shall not be carried away by staggering valuation figures of a company as that will inflate the price of the share. Advertising and media coverage / hype impacts the valuation of a company. Therefore, valuation of a company cannot be solely relied upon for investing in an IPO as it is almost always inflated. A reasonable price of the share will be a prudent investment option. Again, seeking professional guidance on the same will be helpful.
6. The individual tax implication(s) of investing in an IPO should be considered while taking an investment decision. Seeking advice of professionals – chartered accountants, tax practitioners, investment advisors will be immensely helpful.

IPO – going with the flow

Unlike investing in shares of established companies or Mutual funds or even in Portfolio Management Services, investing in in a first time IPO is challenging but not impossible. A company with a very credible Promoter – Management group, consistent track record of performance and reasonable valuation will be successful not only at the time of listing in the stock exchanges but in the long run as well. A good balance of caution and risk will yield maximum gain. Happy investing!