Types of IPO: A complete guide to IPO investing

Introduction 

You may have come across the term IPO a lot recently in the news. It has attracted a lot of new investors to invest in the share market. But, what is an IPO? It is a common way where a company sells its shares to raise finance by going public. 

IPO provides investors access to invest in a company right from the early stage of its growth. It is the most common form of equity financing to raise funds. 

Let’s understand the basics of IPO, how it works and the different types of IPOs in India. 

What is an IPO?

An Initial Public Offering (IPO) is like a company’s launch into the stock market. A private company can go public through an IPO. An IPO option means that the company is ready to sell its equity to the public for the first time.

For investors, an IPO is a medium to join the company’s journey and share in its success by taking ownership via equity investment. When investors buy shares during an IPO, they become shareholders. They own a part of the company’s shares. Shares are the only type of securities in IPO.

This is exciting because as the company grows and does well, the value of those shares can increase. This lets investors make a profit when they decide to sell.

How does an IPO work?

An IPO allows shareholders to become part-owners of the company. Here is the process of how an IPO works.

• The process begins with the private company hiring investment banks. Investment banks help the company navigate the complexities of going public. They also act as underwriters. Together, they follow extensive due diligence. The company’s financial health, operations, and potential risks are examined by the investment banks. They check to ensure everything is in order before the public debut.

• It also includes filing a Draft Red Herring Prospectus (DRHP) with the Securities and Exchange Board of India (SEBI), a regulatory body overseeing securities markets. The DRHP contains essential information about the company and its IPO plans. Following regulatory approval from SEBI, the company releases the final prospectus. 

• Investment banks build the ‘book’ by evaluating aggregated demand. The cutoff price is then determined using a weighted average.

• Once the due diligence is complete, the company, with the support of the investment banks, proceeds to the next step. They engage in strategic marketing to create buzz and interest around their shares. They also make sure to comply with all the rules and regulations set by the stock exchange.

• When the IPO day arrives, the company’s shares are introduced to the public market for investors to purchase. This is called the listing date. Post that comes the allocation day when the shares get allocated to accepted bidders. 

• This process not only opens doors for the company to raise capital but also allows individuals to invest in the company’s success. 

Now that you know how an IPO works, let’s explore the different types of IPO in India.

Different types of IPOs in India

When a company decides to go public, the company has two options. Each type has its own features.

Fixed price offering

A fixed price offering involves setting a fixed price before an IPO begins. In this approach, the company determines a fixed price for its shares in advance of the IPO. This simplicity provides potential investors with a clear and unchanging buying proposition. It comes with a set cost – no surprises, just a clear understanding of the price.

While fixed price offerings provide simplicity, they may lack the flexibility that other IPO structures offer. Investors in IPO have limited room to negotiate. They can express their valuation preferences, as the price is non-negotiable.

Book building offering

On the other end of the spectrum comes the Book Building Offering. It adds a twist to the IPO process. Here, the buyers bid for the price they want to pay for the shares. This is the essence of a Book Building Offering.

In this method, the company does not set a fixed price initially. They establish a price range within which potential investors can bid. Then, they establish the final IPO price based on the demand generated during the bidding process.

For investors, this introduces an element of participation in the pricing mechanism. They can bid within the specified range, reflecting what they believe the shares are worth. This dynamic approach allows the market to decide the optimal price. It can potentially help in achieving a balance between demand and supply.

The Book Building Offering’s flexibility can benefit both the company and investors. It enables the company to capture the market sentiment. It also helps in setting a price that aligns with investor appetite. Investors, in turn, have the opportunity to express their valuation opinions. This enables a more interactive and market-driven IPO experience.

Choosing between a fixed price offering and a book building offering is an important decision. It involves comparing simplicity against flexibility. Companies must consider the nature of their business. They should analyse market conditions and investor preferences. 

For investors, understanding these different IPO types helps them to make smart decisions. They can decide based on their risk tolerance and valuation perspectives. Both Fixed Price and Book Building Offerings contribute unique dynamics to the excitement of a company’s public debut.

Conclusion 

IPO involves a process of moving from private to public ownership. Understanding the types of IPOs is important. A well-planned IPO not only provides companies with access to capital but also establishes a lasting relationship with the public market. 

Whether through a fixed or dynamic pricing strategy, each type of IPO serves as a unique chapter in a company’s journey toward broader financial horizons. To learn more about investing, stay turned to StockGro!

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