When a private company seeks to expand its business, it would need some capital to do that. To do so it gives its ownership rights to the general public. This right is bought for some money and this money can help the company to expand like acquiring new business, increasing assets etc.
How it works?
For example, say the founders of Company ABC want to sell half of their total shares. They require buyers and would like to offer their shares to members of the general public. In order to do that, Company ABC hires an underwriter, which determines the value of the shares and creates an offering agreement that imparts important information about the company to potential buyers. The under writers then conduct the offering, which promotes the sale of the shares to the public via the stock exchange.
Role of underwriters in IPO:
The underwriter is basically an investment bank that hires IPO specialists. These investment bankers ensure that the firm satisfies all the requirements such as depositing all fees, and make all the financial data visible to public. Next, the underwriter contacts large potential buyers of stock, such as mutual funds and insurance companies who used to have lump sum amount of money to invest. The under writers takes up the potential buyer and then offer them an IPO price to the firm. And, this is the initial price at which the shares will get sold.
Where to begin?
IPO can be done by fresh issue of shares to public or through the offer of sale of existing shares to investors as seen in the example, the former case will fetch company additional cash but in the latter case, additional capital is not achieved.
In India, the regulator is Securities exchange board of India (SEBI), to make eligibility to IPO, a company has to satisfy at least one of the followings track record, QIB participation (qualified institutional buyers), appraisal and participation by financial institutions or commercial buyer.
A company can trade its share in Stock exchanges; two major stock exchanges in India are Bombay stock exchange (BSE) and National Stock exchange (NSE). So the company to get listed and to apply for IPO, it should have a demat account, DEMAT account refers to a deposit made at Indian financial institutions that can be used for investing in shares of various stocks and other financial assets. Securities are held electronically in a DEMAT account, thereby eliminating the need for physical paper certificates.
Through this whole process, a private company transforms into a public company as well.
Pro rata in IPOs:
Pro rata describes the proportional distribution of a sum across a number of units. It’s basically a method of allocation of single-unit amounts among several smaller units.
pro rata means:
- Proportional to some factor that can be calculated accurately.
- To count based on amount of time that has passed out of the total time.
- Proportional Ratio.
To buy those shares company has to offer at some price initially, this price is called Issue price. This issue price is calculated by three methods those are fixed price mechanism, book building mechanism, and French auction.
- Fixed price mechanism– Price for shares is fixed before subscription.
- Book building mechanism-Company announces a price band, between this band investors bid and cut off price is determined based on demand and shares are issued at that price only.
- French auction method-There are two types of investors one is a retail investor (individuals) and other is institutional, former has to bid at floor price and later has to bid at higher price(during this process they cannot change their prices) example NTPC used French auction method.