6 IPO terms you must know!

he IPO mania is on.

Everyone is talking about it even if they don't know what it means.

Before you decide to hop on to the bandwagon and apply for the next IPO, get some facts right.

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What is an IPO?

If a brand new company or a company already in existence, but with no shares listed on the stock exchange, decides to invite the public to buy its shares, it is called an Initial Public Offering or an IPO.

Since it is the first time the company is approaching the public for money, it is also referred to as 'going public'.

If a company that is already listed (its shares are available for buying and selling on the stock exchange) is coming out with a fresh lot of shares, it is called the new issue.

Here are six terms commonly associated with an IPO that you, as an investor, must be aware of.

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i. Book building

Book building is the process of price discovery. That means there is no fixed price for the shares.

Instead, the company issuing the shares comes up with a price band. The lowest price is referred to as the floor and the highest, the cap.

Bids are then invited for the shares. Each investor states how many shares s/he wants and what s/he is willing to pay for those shares (depending on the price band).

The actual price is then discovered based on these bids. To understand the entire book building process, read Want to bid for shares?

ii. Allotment

This is the process whereby those who apply are given shares.

According to the book building process, three classes of investors can bid for the shares:

• Qualified Institutional Buyers: QIBs include mutual funds and Foreign Institutional Investors. At least 50% of the shares are reserved for this category.
• Retail investors: Anyone who bids for shares under Rs 50,000 is a retail investor. At least 25% is reserved for this category.
• The balance bids are offered to high net worth individuals and employees of the company.

The bids are first allotted to the different categories and the over-subscription (more shares applied for than shares available) in each category is determined.

Retail investors and high net worth individuals get allotments on a proportional basis.

Assuming you are a retail investor and have applied for 200 shares in the issue, and the issue is over-subscribed five times in the retail category, you qualify to get 40 shares (200 shares/5).

Sometimes, the over-subscription is huge or the issue is priced so high that you can't really bid for too many shares before the Rs 50,000 limit is reached.

In such cases, allotments are made on the basis of a lottery.

Say, a retail investor has applied for five shares in an issue, and the retail category has been over-subscribed 10 times. The investor is entitled to half a share.

Since that isn't possible, it may then be decided that every 1 in 2 retail investors will get allotment. The investors are then selected by lottery and the issue allotted on a proportional basis.

That is why there is no way you can be sure of getting an allotment.

To understand the entire allotment process, read Want to bid for shares?

Any company making a public issue is required to file its prospectus with the Securities and Exchange Board of India, the market regulator.

A prospectus is the document that contains all the information you need about the company. It will tell you why the company is coming is out with a public issue, its financials and how the issue will be priced.

This is called a Draft Offer Document.

This is first filed with SEBI which may specify changes, if any, to be made.

Once the changes are made, it is filed with the Registrar of Companies or the Stock Exchange.

It must be filed with SEBI at least 21 days before the company files it with the RoC/ Stock Exchange.

During this period, you can check it out on the SEBI web site.

iv. Red Herring Prospectus

This is a prospectus that will have all the information as a draft offer document, except details of the price or number of shares being offered or the amount of issue.

That is because it is used in book building issues only, where the details of the final price are known only after bidding is concluded.

So a Red Herring prospectus is an offer document used only in book building issues. All issues these days are through the book building route.

v. Underwriters

An underwriter to the issue could be a banker, broker, merchant banker (see below) or a financial institution. They give a commitment to underwrite the issue.

Underwriting means they will subscribe to the balance shares if all the shares offered at the IPO are not picked up.

Suppose there is an issue is for Rs 100 crore (Rs 1 billion) and subscriptions are received only for Rs 80 crore (Rs 800 million). It is then left to the underwriters to pick up the balance Rs 20 crore (Rs 200 million).

If underwriters don't pay up, SEBI will cancel their licenses.

vi. Lead Manager

Just because the prospectus has been filed with SEBI, it doesn't mean it recommends the issue or guarantees its contents.

That responsibility rests with the lead managers to the issue, who are supposed to do due diligence on the issue. In plain language that means certifying the issue is in accordance with the regulations, proper disclosures have been made and the facts in the prospectus are correct.

They are also called merchant bankers or investment bankers and are in charge of the issue process. Their functions are:

• To act as intermediaries between the company seeking to raise money and the investors. They must possess a valid registration from SEBI enabling them to do this job.
• They are responsible for complying with the formalities of an issue, like drawing up the prospectus and marketing the issue.
• If it is a book building process, the lead manager is also in charge of it. In such a case, they are also called Book Running Lead Managers.
• Post issue activities, like intimation of allotments and refunds, are their responsibility as well.

The actual work of drawing up the list of allottees, crediting the shares to their demat accounts and ensuring refunds is done by the Registrars to the Issue. These are financial institutions appointed to keep a record of the issue and ownership of company shares.

In the case of complaints like non-receipts of shares or refunds, investors must complain to the lead managers, who take up the matter with the registrars.

The names of all the lead managers and the registrar to the issue, with their addresses, phone numbers and e-mail addresses, are displayed prominently on the cover of every prospectus.

On a closing note

Don't forget there are no guarantees in subscribing to IPOs.

The lead manager may have certified the facts as disclosed in the prospectus are right. Prominent financial institutions may agree to underwrite the issue. The issue may end up being oversubscribed.

But the responsibility for investing in an issue rests fairly and squarely on you, the investor.

So make sure you have studied the company and the issue thoroughly before you make the decision to invest.

Illustration: Dominic Xavier