Module 1   Introduction to Stock MarketsChapter 5

The IPO Markets (Part 2)

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5.1 – Overview

This chapter was updated on 15th November 2022. A few comments in the query section may seem out of place. Kindly ignore those comments. The essence of the chapter remains the same.

The previous chapter gave us perspective on how a company evolves from the idea generation stage until it decides to file for an IPO. The idea behind creating the fictional story in the previous chapter was to give you a sense of how a business matures over time. Of course, many nuances were intentionally overlooked to drive the point across, and I hope that helped. The emphasis was on the different stages of business and funding options available at various stages of business.

Ch5-title

Circumstances leading to an IPO are extremely important to understand because the IPO market, also called the Primary market, sometimes attracts many new first-time stock market investors. In this chapter, we will understand the IPO process and the many different aspects of a company’s IPO.

5.2 – Why do companies go public?

We closed the previous chapter with a few unanswered questions: Why did the company decide to file for an IPO, and in general, why do companies go public?

When a company decides to file for an IPO, one of the main reasons is to raise funds to fuel its CAPEX requirement. Apart from this, there are several other reasons for an IPO, sometimes, a company raises funds via IPO to reduce a high-cost debt, or sometimes a company can IPO to give an exit for an early-stage investor. Here is something interesting you can do. Think about a company that went IPO recently, and google for the IPO reason, and you’ll know why the company went public.

The promoter has three advantages in taking his company public –

    1. Raise  funds to meet CAPEX requirement
    2. Avoid the need to raise debt which means there are no finance charges to pay, which further translates to better profitability.
    3. The promoter can spread the risk amongst a large group of investors instead of one large investor. 100s and thousands of retail investors are better than one large private equity investor.

There are other advantages as well in filing for an IPO –

    1. Provide an exit for early investors – Once the company goes public, the shares of the company start trading publicly. Any existing company shareholders– promoters, angel investors, venture capitalists, or PE funds; can use this opportunity to sell their shares in the open market. By selling their shares, they get an exit on their initial investment in the company. Of course, there is a lock-in period before which early investors cant exit, but that is beside the point.
    2. Reward employees –Employees, working for the company would have shares allotted to them as an incentive. This arrangement between the employee and the company is called the “Employee Stock Option” or ESOPS. The shares are allotted at a discount to the employees. Once the company goes public, the employees can see capital appreciation in the shares. A few examples where the employee benefited from ESOP would be Google, Infosys, Twitter, Facebook, Amazon, etc
    3. Improve visibility – Going public increases visibility as the company is publicly held and traded. There is a greater chance of people’s interest in the company, consequently impacting its growth.

5.3 – Merchant Bankers

Having decided to go public, the company must do a series of things to ensure a successful initial public offering. The first and foremost step would be to appoint a merchant banker. Merchant bankers are called Book Running Lead Managers (BRLM)/Lead Managers (LM). The job of a merchant banker is to assist the company with various aspects of the IPO process, including:

    • Conduct due diligence on the company filing for an IPO, ensure their legal compliance and issue a due diligence certificate.
    • Work closely with the company and prepare their listing documents, including Draft Red Herring Prospectus (DRHP). We will discuss this in a bit more detail at a later stage.
    • Underwriting shares – In underwriting shares, merchant bankers agree to take up the unsubscribed portion of an IPO. The underwriting is taken up for fresh shares issued during the IPO. The merchant banker takes up the remaining shares if the subscription is above a defined threshold but is not subscribed fully. If the subscription is below the threshold, the IPO is deemed to have failed. All investor money is unblocked in the investors’ accounts. In March 2020, Anthony Waste Limited IPO’s subscription was below the threshold.
    • Help the company arrive at the price band for the IPO. A price band is the lower and upper limit of the share price within which the company will sell its shares to IPO applicants. For example, the current IPO of Keystone Realtors Limited has a price band of Rs.514 to Rs.541.
    • Help the company with the roadshows. The roadshow is like a promotional/marketing activity for the company’s IPO
    • Appointment of other intermediaries, namely, registrars, bankers, advertising agencies, etc. The Lead manager also makes various marketing strategies for the issue.

Once the company partners with the merchant banker, they will work towards taking the company public.

5.4 – IPO sequence of events

Every step in the IPO sequence must happen under the SEBI guidelines. In general, the following is the sequence of steps involved.

    • Appoint a merchant banker. In case of a large public issue, the company can appoint more than one merchant banker
    • Apply to SEBI with a registration statement – The registration statement contains details on what the company does, why the company plans to go public, and the financial health of the company
    • Getting a nod from SEBI – Once SEBI receives the registration statement, SEBI takes a call on whether to issue a go-ahead or a ‘no go’ to the IPO
    • DRHP – If the company gets the initial SEBI nod, then the company needs to prepare the DRHP. A DRHP is a document that gets circulated to the public. Along with a lot of information, DRHP should contain the following details:
      • The estimated size of the IPO
      • The estimated number of shares being offered to the public
      • Why the company wants to go public, and how does the company plan to utilize the funds along with the timeline projection of fund utilization
      • Business description including the revenue model, expenditure details
      • Complete financial statements
      • Management Discussion and Analysis – how the company perceives future business operations to emerge
      • Risks involved in the business
      • Management details and their background
    • Market the IPO – This would involve TV and print advertisements to build awareness about the company and its IPO offering. This process is also called the IPO roadshow.
    • Fix the price band – Decide the price band between which the company would like to go public. Of course, this can’t be way off the general perception. If it is, then the public will not subscribe to the IPO
    • Book Building – Once the roadshow is done and the price band fixed, the company has to officially open the window during which the public can subscribe for shares. For example, if the price band is between Rs.100 and Rs.120, the public can choose a price they think is fair enough for the IPO issue. The process of collecting all these price points and the respective quantities is called Book Building. Book building is perceived as an effective price discovery method.
    • Closure – After the book building window is closed (generally open for a few days), the price point at which the issue gets listed is decided. This price point is usually the price at which maximum bids have been received.
    • Listing Day – This is the day when the company gets listed on the stock exchange. The listing price is the price decided based on market demand and supply on that day and the stock is listed at a premium, par, or discount of the cut-off price.

5.5 – What happens after the IPO?

During the bidding process, investors can bid for shares at a particular price within the specified price band.  This whole system is referred to as the Primary Market around the date of the issue where one bids for shares. The moment the stock gets listed and debuts on the stock exchange, the stock starts to trade publicly. This is called the secondary market.

Once the stock transitions from primary to secondary markets, the stock gets traded daily on the stock exchange. People transact (buy or sell) these listed shares regularly.

Why do people trade? Why does the stock price fluctuate? We will answer all these questions and more in the subsequent chapters.

5.6 – Few key IPO jargon

Before we wrap up the chapter on IPOs, let us review a few important IPO jargons.

glossaryUnder subscription – Let’s say the company wants to offer 100,000 shares to the public. During the book-building process, it was discovered that only 90,000 bids were received, then the issue is said to be under-subscribed. This is not a great situation, as it indicates negative public sentiment.

glossary Oversubscription – If there are 200,000 bids for 100,000 shares on offer, then the issue is said to be oversubscribed two times (2x)

glossary Green Shoe OptionPart of the issue document that allows the issuer to authorize additional shares (typically 15 percent) to be distributed in the event of oversubscription. This is also called the overallotment option.

glossary Fixed Price IPOSometimes, the companies fix the price of the IPO and do not opt for a price band. Such issues are called fixed-price IPO

glossary Price Band and Cut off priceA price band is a price range between which the stock gets listed. For example, if the price band is between Rs.100 and Rs.130, then the issue can list within the range. Let’s say it gets listed at 125; 125 is the cut-off price.

5.6 – Recent IPOs in India

Here is a look at a few recent IPOs in India. With all the background information you now have, reading this table should be easy.

Sl No Name of Issue IPO Size (INR Crs) BRLM Listing date Price Band (INR)
01 Adani Wilmar Limited 3600 Kotak, JP Morgan, ICIC 8th Feb 2022 218 – 230
02 Delhivery Limited 5235 Kotak, BoFA, Citi 24th May 2022 462 – 487
03 Ethos India 472 Emkay, InCred Capital 30th May 2022 468-472
04 Aether Industries Limited 808 HDFC, Kotak 3rd June 2022 610 – 642
05 Tracxn Technologies Limited 310 IIFL Securities 20th Oct 2022 75 – 80

I hope the last two chapters gave you a sense of why a company files for an IPO and what happens during an IPO. In the next chapter, we focus on understanding the secondary markets and all the nuances around the secondary market.


Key takeaways from this chapter

    1. Companies go public to raise funds, provide an exit for early investors, reward employees and gain visibility.
    2. Merchant banker acts as a key partner with the company during the IPO process.
    3. SEBI regulates the  IPO market and has the  final word on whether a company can go public or not
    4. As an investor in the IPO, you should read through the DRHP to know everything about the company.
    5. Most of the IPOs in India follow a book-building process.

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  1. Praveen says:

    How do underwriters sell there shares? Do they sell in normal market through stock exchange/bulk deal/private placement/offer for sale?

  2. AastroGuru says:

    Karthik,
    Never seen any such educational content clear and lucid.
    Could you add a fictional case of IPO, about prices of book building issue price, bid price range, price discovery, listing price in secondary market?
    I am getting confused with Book Building and issue.
    The content may be clear but the problem could be with me.
    For Eg, an IPO in primary market is set a range for 100-120, for retailers to bid.
    Assume Many people bid 120.
    Then will the issue price will be 120, what will be listing price in the secondary market, will it be same or different?

    • Karthik Rangappa says:

      That is a good idea, maybe we will create additional chapter detailing this.

      In the example you have suggested, bidders will have to bid for a price between 100 to 120…and lets say the price gets fixed to 118. 118 will be the issue price.

      • AastroGuru says:

        Yeah got it, but when it gets listed in the second market, what price it will get listed.
        Example, I bought IPO of 10000 qty (already issued to me), then at what price this will get listed on NSE, on listing day?
        Is it same as 118.

        • Karthik Rangappa says:

          The listing price will depend on how people perceive the stock. For example in the recent Snowman Logistic IPO, the issue price was fixed around 45 but once it debuted on the exchange the price went up all the way to 75.

          • AastroGuru says:

            Oh you mean the opening price on listing day is 75 because market sentiment was good. Cool!

          • akrsrivastava says:

            So you mean that the first tick on the price can be different from 45?

          • Karthik Rangappa says:

            Absolutely!

          • Prashant Agarwal says:

            Karthik – I am still confused pertaining if the issue price in case of the snowman was decided at 45 than how did it jump to 75 at the 1st tick.

            As the normal investor is not allowed to invest at that time. So, is this fluctuation is being conducted by PE firm or Merchant Bankers?

          • Karthik Rangappa says:

            45 was the issued price, but the demand was so much that people were ready to pay a higher price on the day of listing, hence the price increased. Once the stock hits the exchange, anyone can buy or sell the stock.

      • suman says:

        i hav to say ZERODHA/VERSITY is the BEST simple,learning,useful,interactive stuff i come across ever.
        the moto of ZERODHA …….”ZERO RUDDH”…is nice

        i hav 2 qustions
        1st, is the “primary market” bidding through live system(as we see in TRADING TERMINAL) where everyone can see bidding price, bidding quantity,etc? or it just goes offline where we can`t see those?

        2nd, above you mentioned a average amount “bidders will have to bid for a price between 100 to 120…and lets say the price gets fixed to 118. 118 will be the issue price.”…….how this 118(issued price) fixed? how it fix?….is it like…..30no. share @ 115, 40 no.shr @110, 10no. [email protected] 118 after issue the company getes it as a average………or……..within book binding process the rate is fixed…..or any other process?

        • Karthik Rangappa says:

          Good to know you like the content here 🙂

          1) NSE updates this information, check this – http://www.nseindia.com/products/content/equities/ipos/ipo_current_precam.htm?cat=A

          2) The rates are fixed based on the book building process, where in the price point which attracts the maximum amounts of bids is considered for the bidding price.

          • Akshay Ajay says:

            Say if the Maximum bids were received at a stock price of 118, then is it like only those people will be issued stocks on the listing day.

            What happens to the people who had placed the bids at 115 or say 122 like that….

            Will the person who placed a bit at 122 be issued the stocks at 118 value and 115 be rejected?

          • Karthik Rangappa says:

            Yes, listing price is at maximum bids. 122 will get it at 118, but 115 will be rejected. Hence, for this reason, its always best to bid at the highest price.

    • Laxman says:

      Yes, I agree. The way Karthik explains is very clear an simple that layman can understand very easily and take interest to read further.
      Thank you friend Karthik.

    • Laxman says:

      Yes, I agree. The way Karthik explains is a very clear and simple, that layman person like me can also understand very easily and develops interest to read it further.
      Thank you very much Karthik, for such a nice articles .

  3. akrsrivastava says:

    How does an increase or decrease in share price of a company impact the company. Suppose XYZ listed at 100/- The company received 100/- from its each of its new shareholders and proceeded to invest this into its business. Does the future increase or decrease in the price affect in any way, the functioning of the company? If price rises to 120/- in the secondary market, this does not imply that there will be a further inflow of 20/- per share into the company. Hope I made my question clear. The company’s reputation may be at stake, but what apart from that?

    • Karthik Rangappa says:

      After the issue, the increase and decrease of prices do not matter much to the company. Hence there is no additional inflow to the company. However do remember, the promoter (also the business owner) is also a shareholder of the company. If the share price increase/decrease his personal net worth increases/decreases.

      • Akshay Ajay says:

        When the VCs were investing in the coming the valutations were based on the price they were paying for the certain percentage of the equity in the company. Now once the company is publicaly traded if the promoter shareholding will vary based on the stock market price, will the valuations done during funding stage not be valid??

        • Karthik Rangappa says:

          The shareholding will not change…what will change is just the stock price and therefore the valuation. No, once the stock is listed, there is no official valuation of the stock. In fact, the valuation is supposed to happen in the market, which is also called the ‘price discovery’, by the markets.

  4. kashish shambhwani says:

    i have a doubt in book building segment
    say price band is 100-110..now i want to apply for the shares,then at what price should i apply?

    • Karthik Rangappa says:

      Well, this is the whole idea of book building. You can apply at a price you think is fair…for example 107. I could apply at maybe 105..someone else could apply at 110…so on and so forth.

      However to increase the likelihood of allotment, especially for a popular issues, I would recommend applying at the higher cut off, in the example you have suggested it would be 110.

  5. adithyau says:

    Nice explanation .

    Can you please also explain how share are allocated if its over subscribed . Some say they distribute such that atleast one lot we will get and hence its always better to apply just for one lot in case of popular stocks

    And also can you please explain about the price protection if some company offers like 15% price protection . How it works

    • Venu Madhav says:

      Yes, in the recent times SEBI did make such amendements mandating that all issuing companies shall ensure that each retail participant gets a minimum bid lot irrespective of his application size. However this is subject to the availablity of shares.

      So this means, that if the issue is a popular one which is most likely to get oversubscribed, its best to apply for just one lot rather than for multiple lots because the odds of getting allotment of more than the minimum lot is really low.

      This was done with the intention to encourage participation from investors who stay away from IPO’s thinking they won’t get allotment any shares.However the downside to it was those who apply for the full amount are likely to get fewer shares.

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