INITIAL PUBLIC OFFERS (IPO)

The Only 2 ways to buy stocks – Primary markets & Secondary markets.

Hi there,

So far what I have discussed is about share markets or secondary markets. I haven’t talked about primary markets in detail. That’s a basic topic which I should have discussed earlier. So let’s catch up with the topic.

So, there’s only two ways you can buy a stock.

• 1. Through stock markets – those gigantic auction houses where millions of shares are exchanged. ( Also called secondary market)
• 2. IPO’s or initial public offers ( Also called primary market)

WHAT’S THE DFFERENCE?

Companies raise money for expansion through initial public offers. As the name suggests, IPO’s are fresh issue of shares to the public. The money you pay by subscribing shares goes to the company for its expansion plans.So when a company is getting listed for the first time at the stock exchange and issues shares – this process is undertaken at the primary market.Existing companies, who have already issued shares, ,may require additional money for further expansion. If they wish, they can tap if from the primary market . Such share issues will be called ‘follow on issues’.

When you buy shares in the secondary market ( stock markets) , the money which you pay goes to the seller of the shares and not to the company.Generally when we speak about investing or trading at the stock market we mean trading at the secondary stock market. It is the secondary market where we can invest and trade in the stocks to get the profit from our stock market investment.

ISSUE OF SHARES: Face value vs Premium.

When a company launches an IPO to the public, it can offer those shares at ‘face value’ or at a ‘Premium’.

Shares carry a fixed rate, as declared in the legal documents of the company. It’s also called ‘par value’. For example, a company may issue 10 lakhs shares of Rs 10 each at par.

Over and above the fixed rate, a company can issue shares at a premium from its subscribers if the management is able to justify the reason for such premium. For example, a company may issue 10 lakh shares of Rs 10 each at a premium of Rs 50. So the total cost of one share becomes Rs 60.

WHY NOT AT DISCOUNT?

Yes, theoretically speaking, shares can be issued at a discount also. Practically, nobody does that. Shares are either issued at par or at a premium.

IT’s NO EASY PROCESS

To successfully complete the share issue process, a company will have to appoint a lot of intermediaries like –

• Lead managers who would take care of all the paper work with SEBI and other regulatory authorities, with the stock exchanges, bankers, Underwriters, allotment of shares.. in short, everything  from A to Z
• Bankers to the issue who would ensure the collection of funds from the public.
• Registrars to the issue who would scrutinize the applications, reject the disqualified ones and allot the shares to eligible allotees , transfer those shares to their demat accounts and refund the amount to unsuccessful applicants.
• Underwriters who would ‘undertake’ to buy the shares that are not taken up by the public so that the IPO is complete.

PRICING OF SHARE ISSUES.

Shares issued through an IPO can be priced in two ways. First method is straight forward – The company can decide the price at which it will offer it’s shares.

The second method is – The Company, in consultation with the lead managers, would fix a ‘price band’ for the issue. The price band is nothing but a range.  For example If the issue document says that the shares are issued in a price band of Rs 50 to Rs 75. It means, that the investors willing to subscribe the shares are free to bid for any price between that range. The lower end of the band is called the ‘floor price’ and the upper end of the band is called the ‘cap’.

The highest price at which there are maximum numbers of subscribers is taken as the issue price. All bids at or above this price are valid bids and considered for allotment.

INVESTORS WHO CAN INVEST IN AN IPO

The total issue of shares is divided into three parts for three categories of investors. These categories are:

• Retail investors – For You, me, residents, NRIs and Hindu undivided families, whose share application size is less than Rs 1 lakh, 35% of the issue is kept aside.
• Qualified institutional bidders: For mutual funds, banks, insurance companies, foreign institutional investors etc 50% of the issue is kept aside.
• Non-institutional bidders – individuals, companies, NRI’s, HUFs, societies, trusts whose share application size is more than 1 lakh, the balance 15% is given.

This being an article In our primary section, I’m keeping things simple in a layman’s language. We will take up the IPO issue process in our advanced lessons series.

Bye for now..

Have a nice time!