Last Updated on May 24, 2022 by Aradhana Gotur
Money is the basis of any economic activity. Companies also need capital to finance their activities. A company has these options to raise money – own capital, borrowing – either from some third party or bank, issuance of bonds, and issuance of shares. The most common and preferred way is to issue shares.
For example, a company can offer 10 lakh shares of Rs 10 each to the general public and raise Rs 1 cr, if subscribed fully. Of course, the promise to pay a dividend is there. The issuance of shares can be done in a variety of methods. Like private placement, public issue, or initial public offer (IPO), follow on public offer (FPO), offer for sale, and so on. This article focuses on the IPO and FPO processes.
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IPO Meaning
An IPO is the first offer of shares of an enterprise for the general public in exchange for funds to meet its capital requirements. A firm is generally privately owned before it goes public, usually by its founders and possibly family members or initial investors who provided the money to get by. After an IPO, its ownership status changes from private to public company because the company’s ownership is distributed to the masses through the sale of shares. Every shareholder is treated as a part-owner of the company, equivalent to their holding.
How does an IPO market work?
Firstly, underwriting due diligence is used to determine the price of a company’s initial public offering (IPO) shares. When a company goes public, existing private shareholders’ shares are valued at the market price. Under IPO, a company appoints a book-runner, merchant banks, and registrar to issue, initiating a book-building process. A book-building process comprises the determination of price range for bids that are invited from the applicants. Book-runner and registrar to issue open bidding for 4-5 days in which applicants send their bids within a given price band.
The next step is to hire an investment banking firm. The bank’s responsibility is to make the organization public. The price band of the IPO is decided after the valuation of the company. The valuation of the company is the responsibility of the investment banker.
Only after the approval of SEBI can a company go public. A Red Herring Prospectus is prepared and submitted to SEBI. This submission should be completed before its IPO date. Then comes the important element – promotion, fundamentally to create hype. A strong marketing team can make the IPO a great success.
Then, the investment bank arranges the value groups. There will be a higher and lower limit of the bidding values. All bidders will ultimately bid as per these limits. The market value of an oversubscribed IPO increases swiftly.
Who can invest in an IPO?
The qualification measures to invest in the IPO are:
- It is necessary that an individual keen on purchasing an IPO offer has a valid PAN card.
- One needs to have a legitimate demat account, trading account and linked bank account for online investing.
- The amount required for ASBA (Applications Supported by Blocked Amount) until allotment is declared.
How to invest in an IPO?
An IPO can prove a profitable option, but you can not invest in IPOs without research. Investors who want to invest in an IPO should take a few steps to be sure they’re on the right path. Understanding these processes will enable them to invest in an IPO without experiencing any difficulties.
The research
The first step is to do in-depth research on the upcoming IPO, gather all the past records, and do a comparative analysis of the company offering the IPO. You should check:
- The company’s financial status.
- Growth prospect for the company and the industry.
- If it is a delayed IPO and why.
- Recognize the names of promoters to know about the credibility.
- Management track record.
- Read the prospectus to know all risk factors associated with the IPO.
The way of investing
After the research, decide how you want to invest, that is online or offline. For the online method, choose a stockbroker to open a demat account and search the upcoming IPO, select the lot/lots you want to subscribe to and place the bid on the quantity. If the company approves your bid for the shares on the allotment date, you will receive the shares and the subscription status is updated.
The way to gain from IPOs
- Heavy demand for IPO shares of good companies with a proven track record and strong pipeline is generally expected on the first day after its listing on the stock exchange. This is mostly because it is the base price upon which price momentum builds. You may sell your IPO shares to make short term profits.
- For long term gains, you can hold your lot, and reap the benefits of dividends too as the value of the company grows.
FPO meaning
A follow on public offer (FPO) is the issue of additional shares, after the IPO of a company is undertaken to raise some extra capital to finance projects or make acquisitions or reduce debt. In other words, it is the issue of already established companies listed on the stock exchange. It can consist of new shares issued by the company or dilution of the stake of existing private shareholders now available for the public. Whenever a company plans to make an additional offer, it provides a prospectus to the regulators, just like with IPOs.
SEBI’s new regulations for FPOs
Capital markets regulator Securities and Exchange Board of India (SEBI) has relaxed the regulations for FPOs in regards to:
- The applicability of minimum promoters’ contribution
- The subsequent lock-in terms for the issuers
Earlier, the promoters had to contribute 20% mandatorily towards an FPO, and the lock-in term was three years from the date of allotment. This could ease fundraising pains for companies.
Who can invest in FPO?
An individual with a valid PAN card can invest in FPO. Investors already know about the company issuing the follow on public offer and its management; thus, it is considered a safer investment as compared to an IPO. An investor looking for less risky investments in the stock market can consider FPO.
Types of FPOs
Public follow-on offers are divided into two categories:
- Dilutive FPO Issue: This refers to the additional new shares issued for the general public apart from the existing shareholders. It decreases the value per share of the company as this issue increases the outstanding shares of the company, thus automatically reducing the earnings per share.
- Non-Dilutive FPO Issue: This other form is helpful when directors or prominent shareholders dispose off privately held shares. It just increases the number of shares available for the public and not the number of shares of the company. The earnings per share remain unchanged.
How to invest in FPO markets?
You can apply for the FPO online using a demat account with a stock broker. The application process is similar to an IPO. You need to bid for the FPO offer. The fund will be locked under the ASBA (Applications Supported by Blocked Amount). You can instruct your broker to submit the FPO request.
Key differences between IPO and FPO
| IPO | FPO |
| It is the first issue of shares for the public. | FPO is the secondary issue of shares of already-listed companies. |
| IPO is related to raising capital with the issue of new securities for the first time. | It is the secondary issue of shares for additional capital. |
| IPO means an increase in the share capital of the company. | The non-dilutive FPO does not increase the share capital. |
| It is a risky route for investors. | It is less risky as compared to an IPO. |
IPO is one of the preferred options among companies to go public. The public status benefits the company in numerous ways. During 2020, India witnessed some of the most astonishing IPOs where the institutional investor quota was oversubscribed 77 times. Non-institutional investors were given around six million shares, which were subscribed 351 times.
IPOs may be a profitable investment for investors with potential to provide significant gains in the long run, provided the company has a proven track record of results and a clear pipeline visible for the future. Listing gains are another reason why investors flock to IPOs. The FPO proves to be the most favourable alternative for companies as it assists to reduce debt and modify the existing capital structure.
