IPO - Initial Public Offering:
The first sale of stock by a private company to the public in the Primary Market. IPOs are often issued by smaller, younger companies seeking the capital to expand, but can also be done by large privately owned companies looking to become publicly traded.
In an IPO, the issuer obtains the assistance of an underwriting firm, which helps it determine what type of security to issue (common or preferred), the best offering price and the time to bring it to market.Investors purchasing stock in IPOs generally must be prepared to accept very large risks for the possibility of large gains. Sometimes, Just before the IPO is launched, Existing share Holders get a very liberal bonus issues as a reward for their faith in risking money when the project was new.
Private v/s Public Companies:
A privately held company has fewer shareholders and its owners do not have to disclose much information about the company. Anybody can go out and incorporate a company: just put in some money, file the right legal documents and follow the reporting rules of your jurisdiction. Most small businesses are privately held. But large companies can be private too.
It usually is not possible to buy shares in a private company. You can approach the owners about investing, but they're not obligated to sell you anything. Public companies, on the other hand, have sold at least a portion of themselves to the public and trade on a Stock Exchange.
How to apply to an IPO:
To apply to an IPO you have to fill an IPO application form. These forms are available in stalls outside the stock exchanges and with vendors in various other areas. You can also get an application form through a share broker or investment consultant, if you have one. Else forms are available at various banks.
Once you get the form, you have to fill it, remit the amount after calculating the number of shares applied for in the bank that is designated in the form as collecting centre for that IPO.
If you have a Demat Account, then you can apply for the shares directly through your demat account or there is an option of physical delivery of share certificates. Some IPOs offer only demat (dematerialised) form of shares, while others offer both demat as well as regular (physical) shares.
SEBI advises investors to get the allotment in demat form as the shares in IPO are tradable only in demat segment in the stock exchanges. Dealing of physical shares (allocated in IPO) is not accepted.
Factors that need to keep in mind before apply to an IPO:
- Track record of the promoters: Background and experience of the promoters, the management team and their expertise is one of the main factors that needs to be considered as they will be the ones responsible for the profitability of the company. Studying this point will help investors avoid fly by night promoters and companies.
- Financials: The company's balance sheet is a very important document and investors should look at it carefully. Investors should look at not just the current balance sheet but also that of the last three to four years to get an idea of the company's growth and focus.
- Prospectus: Read the prospectus for the company carefully. The prospectus called as red-herring prospectus is a document that every company that goes for a public offering has to file with the SEBI.
The prospectus has all the details about the company, the risk factors and the company's financials. You can get the prospectus for companies going public at the SEBI Website: http://www.sebi.gov.in/Index.jsp?contentDisp=Department&dep_id=1
- Issue price: Investors need to decide if the issue is worth investing in at that price. One way of checking the valuation is to look at the Price-Earnings (P/E) multiple.
The P/E multiple is the ratio of the share price to earnings per share (EPS which is listed in the balance sheet). P/E of the issue should be compared with the industry average and the other companies in that sector. Apart from these three important points other factors like amount to be paid on application, the lead managers for the issue, the stock exchanges that issue plans to list on and the current market sentiment are other factors to watch out for.
Price band comes into play when IPOs are done through a Book-building process. IPOs if they have gone for the book-building route will mention aPrice Band.Book-building
Who decides the Price Band?
It may be understood that the regulatory mechanism does not play a role in setting the price for issues. It is up to the company to decide on the price or the price band, in consultation with Merchant Bankers.
Book-building is a mechanism where, during the period for which the IPO is open, bids are collected from investors at various prices which are above or equal to the floor price (the minimum price). The final price of the share is determined after the bid closing date, based on certain evaluation criteria.
Individual investors are encouraged to bid at the floor price. When all the bids are received and the final price is decided, those who have got the allotments will have to pay that price, irrespective of the price they had bid on. So price band indicates the range which the investment bankers think that the share is likely to be priced in.